2

Material
Learning Objectives
After studying this chapter you will be able to:

Understand the concept of materials,

Understand its need and importance.
Describe the procedures involved in procuring, storing and issuing material.
Differentiate amongst the various methods of valuing material.
Evaluate different methods of pricing material issues, material received and material return.
Understand the meaning and accounting treatment for normal and abnormal loss of 0material.
Understand the meaning and the accounting treatment of waste, scrap, spoilage and
defectives.

2.1 Introduction
We have acquired a basic knowledge about the concepts, objectives, advantages, methods
and elements of cost. We shall now study each element of cost separately begin with material.
The general meaning of material is all commodities/ physical objects supplied to an
organization. It may be direct material or indirect material. Materials constitute a very
significant portion of total cost of finished product. A proper recording and control over the
material costs is very essential. Importance of proper recording and control of material are
following:
(a) Dependence of the Quality of finished product: The exact quality of materials required
should be determined according to the required quality of the finished product. Quality and
cost both should be given equal consideration.
(b) Price of the product: The price paid should be the minimum possible otherwise the
higher cost of the finished products would make the product uncompetitive in the market.
(c) Continuity in production: There should not be any interruption in the production
process for want of materials and stores, including small inexpensive items like lubricating oil
for a machine.

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2.2

Cost Accounting

(d) Cost of holding material: There should be no over stocking of materials because that
would result in loss of interest charges, higher warehouse charges, deterioration in quality and
losses due to obsolescence
(e) Wastages: Wastage and losses while the materials are in store and during the process
of manufacture should be avoided as far as possible; and
(f) Regular Information about resources: It may also be added that information about
availability of materials and stores should be continuously available so that production may be
planned properly and the required materials purchased in time.

2.2 Material control

The publication of the Institute of Cost and Management Accountants (CIMA) on Budgetary
Control defines it as The function of ensuring that sufficient goods are retained in stock to
meet all requirements without carrying unnecessarily large stocks.

2.2.1 Objectives of system of material control: The objectives of a system of material

control are the following:
(i)

Minimising interruption in production process: Ensuring that no activity, particularly

production, suffers from interruption for want of materials and stores. It should be noted
that this requires constant availability of every item that may be needed howsoever small
its cost may be.

(ii) Cost of Material: Seeing to it that all the materials and stores are acquired at the lowest
possible price considering the quality that is required and considering other relevant
factors like reliability in respect of delivery, etc. Holding cost should also be tried to be
minimized.
(iii) Reduction in Wastages: Avoidance of unnecessary losses and wastages that may arise
from deterioration in quality due to defective or long storage or from obsolescence. It may
be noted that losses and wastages in the process of manufacture, concern the
production department.
(iv) Adequate Information: Maintenance of proper records to ensure that reliable
information is available for all items of materials and stores that not only helps in
detecting losses and pilferages but also facilitates proper production planning.
(v) Completion of order in time: Proper material management is very necessary for
fulfilling orders of the firm. This adds to the goodwill of the firm.

2.2.2 Requirements of material control: Material control requirements can be summarised

as follows:
1.

Proper co-ordination of all departments involved viz., finance, purchasing, receiving,

inspection, storage, accounting and payment.

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Material

2.3

2.

Determining purchase procedure to see that purchases are made, after making suitable
enquiries, at the most favourable terms to the firm.

3.

Use of standard forms for placing the order, noting receipt of goods, authorising issue of
the materials etc.

4.

Preparation of budgets concerning materials, supplies and equipment to ensure economy

in purchasing and use of materials.

5.

Operation of a system of internal check so that all transactions involving materials,

supplies and equipment purchases are properly approved and automatically checked.

6.

Storage of all materials and supplies in a well designated location with proper
safeguards.

7.

Operation of a system of perpetual inventory together with continuous stock checking so that
it is possible to determine at any time the amount and value of each kind of material in stock.

8.

Operation of a system of stores control and issue so that there will be delivery of materials
upon requisition to departments in the right amount at the time they are needed.

9.

Development of system of controlling accounts and subsidiary records which exhibit

summary and detailed material costs at the stage of material receipt and consumption.

10. Regular reports of materials purchased, issue from stock, inventory balances, obsolete
stock, goods returned to vendors, and spoiled or defective units.

2.2.3 Elements of Material Control: Material control is a systematic control over the
procurement, storage and usage of material so as to maintain an even flow of material.
Material control involves efficient functioning of the following operations:

Purchasing of materials

Receiving of materials

Inspection of materials

Storage of materials

Issuing of materials

Maintenance of inventory records

Stock audit.

2.3 Materials Procurement Procedure

Material procurement procedure can be understood with help of the following diagram.
Documents required and the departments who initiate these documents are shown
sequentially.

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2.4

Cost Accounting

Production Department
/ Work Shop

1. Bill of Materials

Engineering/ Planning
Department

2. Material Requisition

6. Purchase Order
r

4. Tender or Request for proposal (RFP)

11. Goods Received Note

12. Material Returned Note

13. Material Abstract

10. Goods delivery with

Challan or/and Invoice

Purchase Department

5. Quotation

3. Purchase Requisition

Store

12. Material Returned Note

Cost/ Accounting
Department

Supplier(s)
7. Performa Invoice
8. Payment and Form-C
9. Invoice

Diagram: Material Procurement Procedure

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Material

2.3.1

2.5

Bill of Materials: It is also known as Materials Specification List or simply Materials

List. It is a schedule of standard quantities of materials required for any job or other unit of
production. A comprehensive Materials List should rigidly lay down the exact description and
specifications of all materials required for a job or other unit of production and also required
quantities so that if there is any deviation from the standard list, it can easily be detected. The
materials specification list is prepared by the Engineering or Planning Department in a
standard form. The numbers of copies prepared vary according to the requirement of each
business. Generally Bill of Material is sent to Production control department, Store
department, Cost/ Accounting department and a copy retained with engineering or planning
department. A proforma of Bill of Materials is as follows:
Bill of Materials
Job No. .............................................

No. ......................................

Department authorised ...............

Date ...................................

Sl.

Code

No.

No. or

Description

Qty.

Date of

Rate

Amount

issue & Qty.

issued
Date

Authorised by ..................................................

Qty.

Received by .........................
Checked by ..........................

Store Keepers signature .............................

Cost clerk .............................

The advantages of using bill of materials, by the concerned departments may be

summed up as follows:
Stores Department :
1.
2.
3.

A bill of material serves as an important basis of preparing material purchase requisitions

by stores department.
It acts as an authorisation for issuing total material requirement.
The clerical activity is reduced as the stores clerk issues the entire/part of the material
requirement to the users if the details of material asked are present in the bill of
materials.

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2.6

Cost Accounting

Cost Accounts Department:

1.
2.

Bill of material, is used by Cost Accounts department for preparing an estimate/budget of

material cost for the job/process/operation, it is meant.
It may be used as a device for controlling the excess cost of material used. This is done
after determining material variances and ascertaining the reasons for their occurrence.

Production Control Department:

1.
2.

Bill of material may be used by this department for controlling usage of materials.
Its usage saves time which otherwise would have been wasted for preparing separate
requisitions of material.

Engineering or Planning department: As stated earlier this department prepares the

materials list in a standard form. A copy of list is sent to stores, cost accounts and production
control department.

2.3.2 Material Requisition Note: It is also known as material requisition slip, It is the
voucher of the authority regarding issue of materials for use in the factory or in any of its
departments. Generally it is prepared by the production department and materials are
withdrawn on the basis of material requisition list or bill of materials. If no material list has
been prepared, it is desirable that the task of the preparation of material requisition notes be
left to the planning department or by the department requires the materials. Usually, a
foremans authority is enough but, in the case of costly materials, it would be desirable to have
such requisitions duly approved by some higher authority, like the superintendent or works
manager before these are presented to Stores. Apart from sending a material requisition to
store a copy is sent to cost accounting department and one copy is retained as office copy.
A specimen form of the Material Requisition is shown below:
Material Requisition Note
Work Order No. ............................

No. ..........................................

Department .....................................

Date .......................................

Item No.

Store-keeper

Particulars

Qnty.

Workman receiving
the material

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Rate

Amount

Foreman

S.L. Clerk

Material

2.7

Difference between Bill of Materials and Material Requisition Note:

Bill of Materials
1.
2.

3.

4.
5.

2.3.3

It is the document prepared by the

drawing office.
It is a complete schedule of component
parts and raw materials required for a
particular job or work order.
It often serves the purpose of a Stores
Requisition as it shows the complete
schedule of materials required for a
particular job i.e. it can replace stores
requisition.
It can be used for the purpose of
quotations.
It helps in keeping a quantitative control
on materials drawn through stores
Requisition.

Material Requisition Note

1.
2.

3.

4.
5.

It is prepared by the Foreman of the

consuming department.
It is a document authorizing Storekeeper to issue materials to the
consuming department.
It cannot replace a bill of materials.

It is useful in arriving historical cost

only.
It shows the material actually drawn
from stores.

Purchase Requisition: Since the materials purchased will be used by the

production departments, there should be constant co-ordination between the purchase and
production departments. A purchase requisition is a form used for making a formal request to
the purchasing department to purchase materials. This form is usually filled up by the store
keeper for regular materials and by the departmental head for special materials (not stocked
as regular items). The requisition form is duly signed by either works manager or plant
superintendent, in addition to the one originating it. At the beginning a complete list of
materials and stores required should be drawn up, the list should have weekly consumption
figures. It should be gone through periodically so that necessary deletion and addition may be
made. If there is any change in the rate of consumption per week (say, due to extra shift being
worked), the purchase department should be informed about the new figures. Once an item
has been included in the standard list, it becomes the duty of the purchase department to
arrange for fresh supplies before existing stocks are exhausted. But if the production
department requires some new material, it should make out an indent well in time and send it
to the purchase department for necessary action.
For control over buying of regular store materials it is necessary to determine their maximum,
minimum, reorder level and economic order quantities. The use of economic order quantities
and various levels constitutes an adequate safeguard against improper indenting of regular
materials. In respect of special materials, required for a special order or purpose, it is
desirable that the technical department concerned should prepare materials specifications list
specifying the quantity, size and order specifications of materials to be drawn from the store
and those to be specially procured. It may originate either in the stores department in
connection with regular stock of materials or in the production planning or in other technical

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Cost Accounting

departments concerned in respect of special materials. Its purpose is to request and authorise
the purchase department to order to procure the materials specified in stated quantities. It
should be made out in triplicate and send to following.
Purchase Requisition (Regular/Special)
(Use a separate form for each item)
No..................
Date.............

Department.................................

Purchase...................

Date by which material required...............................

Description of

Quantity

Materials required

required

Exact specification

Indentor
For use in purchase department
Firm

1.

2.

3.

Quotations

Order
No. & Date...........................

.......................................................................................
Price (including charges)

With......................................

.......................................................................................
Price...............................
Date of Delivery

Date of dly...................

.......................................................................................
Remarks

Purchase Manager

2.3.4 Inviting Tender/ Requesting for proposal (RFP): After receipt of purchase

requisition from the store department or other competent departments, role of purchasing
department comes into play. If a concern can afford or the size of the concern is big enough,
there should be a separate purchase department for all purchases to be made on behalf of all
other departments. Such a department is bound to become expert in the various matters to be

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Material

2.9

attended to, for examples units of materials to be purchased and licences to be obtained,
transport, sources of supply, probable price etc.
Materials purchase department in a business house is confronted with the following issues:
(i)

What to purchase?

(ii)

When to purchase?

(iii) How much to purchase?

(iv) From where to purchase.
(v)

At what price to purchase.

To overcome these questions, purchase department make an enquiry into the market for the
required material. The process of gathering information about the rate, quantity, technology,
services and support etc., purchase department sent RFP to selected vendors in case if
purchase policy allows this practice. Some organizations follow the open and transparent
purchase policy and invite quotation from the interested vendors. This process is called
Tender Notification or Invitation of Tender.

2.3.5 Selection of Quotation/ Proposal: After invitation of tender from the vendors, interested
vendors who are fulfilling all the criteria mentioned in the tender notice send their price quotations/
proposals to the purchase department. On the receipt of quotations a comparative statement is
prepared. For selecting material suppliers the factors which the purchase department keeps in
its mind areprice; quantity; quality offered; time of delivery; mode of transportation; terms of
payment; reputation of supplier; etc. In addition to the above listed factors purchase manager
obtains other necessary information from the statement of quotations; past records, buyer
guides etc. for finally selecting material suppliers.
2.3.6 Preparation and execution of Purchase Orders: Having decided on the best
quotation that should be accepted, the purchase manager or concerned officer proceeds to
issue the formal purchase order. It is a written request to the supplier to supply certain
specified materials at specified rates and within a specified period. Generally copies of
purchase order are given to Store or order indenting department, receiving department and
cost accounting department. A copy of the purchase order, alongwith relevant purchase requisitions, is held in the file of the department to facilitate the follow-up, of the delivery and also
for approving the invoice for payment.
2.3.7 Receipt and inspection of materials: After execution of purchase order and advance
payment (if terms of quotation so specified), necessary arrangement is made to receive the
delivery of materials (in case of inter-state purchase Form-C (way bill) is get issued by the
purchase or accounting department). After receipt of materials along with challan or/ and
invoice, Receiving department arrange to inspect the materials for its conformity with purchase
order. After satisfactory inspection materials are received and Goods Received Note is issued.
If some materials are not found in good condition or not in conformity with the purchase order
are returned back to the vendor alongwith a Material Returned Note.

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2.10

Cost Accounting

2.3.7.(i) Goods Received Note: If everything is in order and the supply is considered

suitable for acceptance, the Receiving department prepares a Receiving Report or Material
Inward Note or Goods Received Note. Generally it is prepared in quadruplicate, the copies
being distributed to purchase department, store or order indenting department, receiving
depart and accounting department.
A specimen form of the receiving report is given below:
Goods Received Note

Received from..............................

No. ..............

Order No. ..................

Date............................
Amount

Quantity

Code

Description

Amount
due to
supplier

Charges

Total

Remarks

`
Inspector.......................

Store Keeper..................................

Receiver........................

Store Ledger Clerk......................

2.3.7.(ii) Material Returned Note : Sometimes materials have to be returned to suppliers

after these have been received in the factory. Such returns may occur before or after the
preparation of the receiving report. If the return takes place before the preparation of the
receiving report, such material obviously would not be included in the report and hence not
debited in the stores books and ledgers. In that case, no adjustment in the account books
would be necessary. But if the material is returned after its entry in the receiving report, a
suitable document must be drawn up in support of the credit entry so as to exclude from the
Stores of Material Account the value of the materials returned back. This document usually
takes the form of a Material Returned Note or Material outward return note.
The Material outward return note is drawn up by the Stores or the Despatch Department. Five
copies of it are usually prepared; two for the supplier (one of which is to be sent back by the
supplier after he has signed the same), one for Store, one for Cost (stores) Ledger and one
copy to be retained in the Material outward return book.

2.3.8 Checking and passing of bills for payment: The invoice received from the supplier
is sent to the stores accounting section to check authenticity and mathematical accuracy. The
quantity and price are also checked with reference to goods received note and the purchase
order respectively. The stores accounting section after checking its accuracy finally certifies
and passes the invoice for payment. In this way the payment is made to supplier.

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Material

2.11

2.4 Valuation of Material Receipts

After the procurement of materials from the supplier actual material cost is calculated.
Ascertainment of cost of material purchased is called valuation of materials. Cost of material
includes cost of purchase net of trade discounts, rebates, duty draw-back, Cenvat credit
availed, etc. and other costs incurred in bringing the inventories to their present location and
condition. The invoice of material purchased from the market sometime contain items such as
trade discount, quantity discount, freight, duty, insurance, cost of containers, sales tax, excise
duty, cash discount etc.
Treatment of items associated with purchase of materials is tabulated as below
Sl
no.

Items

Treatment

Discounts and Subsidy

(i)

Trade Discount

Trade discount is deducted from the purchase price if it

is not shown as deduction in the invoice.

(ii)

Quantity Discount

Like trade discount quantity discount is also shown as

deduction from the invoice. It is deducted from the
purchase price if not shown as deduction.

(iii)

Cash Discount

Cash discount is not deducted from the purchase price.

(iv)

Subsidy/
Incentives

Grant/

Any subsidy/ grant/ incentive received from the

Government or from other sources deducted from the
cost of purchase.

Duties and Taxes

(v)

Road Tax/ Toll Tax

Road tax/ Toll tax if paid by the buyer then it is included

with the cost of purchase.

(vi)

Octroi/ Entry Tax

Octroi/ Entry tax is collected by the Panchayats/

Municipalities. It is added with cost of purchase if it is
born by the buyer.

(vii)

Central
(CST)

Tax

Central Sales Tax (CST) is paid on inter-state sale and

collected from the buyers. The buyer is not getting any
credit for tax paid hence it is added with cost of
purchase.

(viii)

State Sales tax or

Value Added Tax
(VAT)

State Sales Tax/ VAT is paid on intra-state sale and

collected from the buyers. It is excluded from the cost of
purchase if credit for the same is available. Unless
mentioned specifically it should not form part of cost of
purchase.

Sales

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2.12

Cost Accounting

(ix)

Excise Duty

Excise duty is paid on manufacture of goods and

collected from the buyer. It is excluded from the cost of
purchase if credit (CENVAT) is available for the same.
Unless mentioned specifically excise duty is not added
with the cost of purchase.

(x)

Custom Duty

Custom duty is paid on import of goods from outside

India. It is added with the purchase cost.

(xi)

Purchase Tax

It is a tax paid on purchase of goods from unregistered

supplier. Credit on purchase tax is available hence
unless specifically mentioned it is not added with the
cost of purchase.

Penalty and Charges

(xii)

Demurrage

(xiii)

Detention
Fine

(xiv)

Penalty

Demurrage is a penalty imposed by the transporter for

delay in uploading or offloading of materials. It is an
abnormal cost and not included with cost of purchase
charges/

Detention charges/ Fine is imposed for non compliance

of rule or law by any statutory authority. It is an abnormal
cost and not included with cost of purchase
Penalty of any type is not included with the cost of
purchase

Other expenditures
(xv)

Insurance charges

Insurance charges are paid for protecting goods during

transit. It is added with the cost of purchase.

(xvi)

Commission
brokerage paid.

(xvii)

Freight inwards

It is added with the cost of purchase as it is directly

attributable to procurement of material.

(xviii)

Cost of containers

Treatment of cost of containers are as follows:

or

Commission or brokerage paid is added with the cost of

purchase.

Non-returnable containers: The cost of containers is

added with the cost of purchase of materials.
Returnable Containers: If on return of containers cost of
containers is returned back then in this case cost of
containers is not added with the cost of purchase.
If the amount of refund on returning the container is less
than the amount paid then only short fall is added with
the cost of purchase.

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Material
(xix)

Shortage

2.13

Shortage in materials are treated as follows:

Shortage due to normal reasons: Good units absorb the
cost of shortage due to normal reasons. Losses due to
breaking of bulk, evaporation, due to unavoidable
conditions etc. are the reasons of normal loss.
Shortage due to abnormal reasons: shortage arises due
to abnormal reasons such as material mishandling,
pilferage, due to avoidable reasons are not absorbed by
the good units. Losses due to abnormal reasons are
debited to costing profit and loss account.

Illustration 1: (Treatment of items associated with purchase of material)

An invoice in respect of a consignment of chemicals A and B provides the following information:
(`)
Chemical A: 10,000 kgs. at ` 10 per kg.

1,00,000

Chemical B: 8,000 kgs. at ` 13 per kg.

1,04,000

Central Sales tax @ 10%

20,400

Railway freight

3,840

Total cost

2,28,240

A shortage of 500 kgs. in chemical A and 320 kgs. in chemical B is noticed due to normal
breakages. You are required to determine the rate per kg. of each chemical, assuming a
provision of 2% for further deterioration.
Solution
Statement showing computation of effective quantity of each chemical available for use

Quantity purchased
Less : Shortage due to normal breakages
Less : Provision for deterioration 2%
Quantity available

The Institute of Chartered Accountants of India

Chemical A

Chemical B

(kgs.)

(kgs.)

10,000

8,000

500

320

9,500

7,680

190

153.6

9,310

7,526.4

2.14

Cost Accounting

Statement showing the computation of rate per kg. of each chemical

Purchase price

Add : Central Sales tax (10%)

Railway freight (in the ratio of quantity purchased i.e., 5:4)
Total cost
Rate per kg. A :

` 1,12,133
= ` 12.04
9,3101bs

Rate per kg. B :

` 1,16,107
= ` 15.43
7,526.41bs

Chemical A
(`)

Chemical B
(`)

1,00,000

1,04,000

10,000

10,400

2,133

1,707

1,12,133

1,16,107

Illustration 2: (Treatment of items associated with purchasing of material)

At what price per unit would Part No. A 32 be entered in the Stores Ledger, if the following
invoice was received from a supplier:
Invoice
200 units Part No. A 32 @ ` 5
Less : 20% discount

(`)
1,000.00
200.00
800.00
120.00
920.00
50.00
970.00

Add : Excise duty @ 15%

Add : Packing charges (5 non-returnable boxes)
Notes:
(i)
(ii)

A 2 per cent discount will be given for payment in 30 days.

Documents substantiating payment of excise duty is enclosed for claiming CENVAT credit.

Solution
200 units net cost after trade discount
Add : Packing charges
Total cost per 200 units
` 850
Cost per unit =
= ` 4.25
200

` 800
` 50
` 850

2.5 Material Storage & Records

Proper storing of materials is of primary importance. It is not enough only to purchase material

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Material

2.15

of the required quality. If the purchased material subsequently deteriorates in quality because
of bad storage, the loss is even more than what might arise from purchase of bad quality
materials. Apart from preservation of quality, the store-keeper also must ensure safe custody
of the material. It should be the function of store-keeper that the right quantity of materials
always should be available in stock.

2.5.1 Duties of store keeper: These can be briefly set out as follows :
(i)

(ii)
(iii)
(iv)
(v)

(vi)
(vii)

General control over store: Store keeper should keep control over all activities in
Stores department. He should check the quantities as mentioned in Goods received note
and with the purchased materials forwarded by the receiving department and to arrange
for the storage in appropriate places.
Safe custody of materials: Store keeper should ensure that all the materials are stored
in a safe condition and environment required to preserve the quality of the materials.
Maintaining records: Store keeper should maintain proper record of quantity received,
issued, balance in hand and transferred to/ from other stores.
Initiate purchase requisition: Store keeper should initiate purchase requisitions for the
replacement of stock of all regular stores items whenever the stock level of any item of
store approaches the re-order level fixed.
Maintaining adequate level of stock: Store keeper should maintain adequate level of
stock at all time. He/ she should take all necessary action so that production could not be
interrupted due to lack of stock. Further he/ she should take immediate action for
stoppage of further purchasing when the stock level approaches the maximum limit. To
reserve a particular material for a specific job when so required.
Issue of materials: Store keeper should issue materials only against the material
requisition slip approved by the appropriate authority. He/ she should also refer to bill of
materials while issuing materials to requisitioning department.
Stock verification and reconciliation: Store keeper should verify the book balances
with the actual physical stock at frequent intervals by way of internal control and check
the any irregular or abnormal issues, pilferage, etc.

2.5.2 Store Records: The record of stores may be maintained in three forms:

Bin Cards

Stock Control Cards

Store Ledger

Bin Cards: Bin refers to a box/ container/ space where materials are kept. Card is placed with
each of the bin (space) to record the details of material like receipt, issue and return. The first
two forms are records of quantities received, issued and those in balance, but in the third
record i.e. store ledger, value of receipts, issues and closing balance is also maintained.
Usually, records of quantities i.e. Bin cards and Store Control Cards are kept by the store
keeper in store department while record of both quantity and value is maintained by cost
accounting department.

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2.16

Cost Accounting

Stock Control Cards: It is a record keeping document maintained by stores department for
every item of material. Recording includes receipt, issue, return, in hand and order given.
Advantages and Disadvantages of Bin Cards:
Advantages
(i)

(ii)

(iii)

There would be fewer chances of

mistakes being made as entries will
be made at the same time as goods
are received or issued by the person
actually handling the materials.
Control over stock can be more
effective, in as much as comparison
of the actual quantity in hand at any
time with the book balance is
possible.
Identification of the different items of
materials is facilitated by reference
to the Bin Card the bin or storage
receptacle.

Disadvantages
(i)

Store records are dispersed over a

wide area.

(ii)

The cards are liable to be smeared

with dirt and grease because of
proximity to material and also
because of handling materials.

(iii)

People handling materials are not

ordinarily suitable for the clerical
work involved in writing Bin Cards.

Advantages and disadvantages of Stock Control Cards

Advantages
(i)
(ii)

(iii)

Records are kept in a more compact (i)

manner so that reference to them is
facilitated.
Records can be kept in a neat and (ii)
clean way by men solely engaged in
clerical work so that a division of
labour between record keeping and
actual material handling is possible.

Disadvantages
On the spot comparison of the
physical stock of an item with its
book balance is not facilitated.
Physical identification of materials in
stock may not be as easy as in the
case of bin cards, as the Stock
Control Cards are housed in cabinets
or trays.

As the records are at one place, it is

possible to get an overall idea of the
stock position without the necessity
of going round the stores.

Stores Ledger: A Modern Stores Ledger is a collection of cards or loose leaves specially
ruled for maintaining a record of both quantity and cost of stores received, issued and those in
stock. It being a subsidiary ledger to the main cost ledger, it is maintained by the Cost
Accounting Department. It is posted from Goods Received Notes and Materials requisition.

The Institute of Chartered Accountants of India

Material

2.17

The advantages of writing up Stores Ledger mechanically are:

(i)
(ii)
(iii)
(iv)
(v)

Distribution of work: It enables distribution of work among a number of clerks due to

which receipts and issues are posted quickly and regularly.
Centralised record: It enables stock records to be centralised in case of an organisation
having a number of depots.
Testing of accuracy: The accuracy of posting can be mechanically tested more
conveniently.
Cost effective: The records are clearer and neater. Also the recurring cost of
maintaining them is much less than those kept manually.
Control over stock: If up-to-date records are available, the management will be able to
exercise greater control over quantities held in stock from time to time which may result
in a great deal of saving in both the amount of investment in stock and their cost.

Difference between Bin Card & Stores Ledger

Bin Card

Stores Ledger

It is maintained by the storekeeper in the

store.

It is maintained in costing department.

It contains only quantitative details of

material received, issued and returned to
stores.

It contains information both in quantity and

value.

Entries are made when transactions take

place.

It is always posted after the transaction.

Each transaction is individually posted.

Transactions may be summarized and then

posted.

Inter-department transfers do not appear in

Bin Card.

Material transfers from one job to another job

are recorded for costing purposes.

2.6 Inventory Control

The main objective of inventory control is to achieve maximum efficiency in production and
sales with the minimum investment in inventory. Inventory comprises of stocks of raw
materials, stores & consumables, work-in-progress, and finished products. The techniques
commonly applied for inventory control are as follows:
Techniques of Inventory control:
(i)

Setting of various stock levels.

(ii)

ABC analysis.

(iii)

Two bin system.

The Institute of Chartered Accountants of India

2.18

Cost Accounting

(iv)

Establishment of system of budgets.

(v)

Use of perpetual inventory records and continuous stock verification.

(vi)

Determination of economic order quantity.

(vii)

Review of slow and non-moving items.

(viii) Use of control ratios.

2.6.1 Setting of various stock levels:

(i) Re-Order Quantity: Re-order quantity is the quantity of materials for which purchase
requisition is made by the store department. While setting quantity to be re-ordered consideration
is given to the maintenance of minimum level of stock, re-order level, minimum delivery time and
the most important cost.
Economic Order Quantity (EOQ)
Meaning

Factors

The size of the order for

which both ordering and
carrying cost are minimum
is known as economic order
quantity or EOQ.

Ordering Cost: The costs

which are associated with
the purchasing or ordering
of material. It includes costs
of
tender
invitation,
preparation of purchase
orders, staff posted for
ordering
of
goods,
expenses
incurred
on
transportation of goods
purchased, inspection cost
of incoming material etc.

Formula
EOQ

2AO
C

where,
A

Annual
units

Ordering cost per

order

Annual carrying
cost of one unit,
i.e.,
carrying
cost percentage
cost of one
unit.

Carrying Cost: The costs

for holding the inventories.
It includes the cost of
capital
invested
in
inventories, cost of storage,
insurance cost etc.

usage

Assumptions underlying E.O.Q.: The calculation of economic order of material to be

purchased is subject to the following assumptions:
(i)
(ii)

Ordering cost per order and carrying cost per unit per annum are known and they are fixed.
Anticipated usage of material in units is known.

(iii)

Cost per unit of the material is constant and is known as well.

The Institute of Chartered Accountants of India

Material
(iv)

2.19

The quantity of material ordered is received immediately i.e. the lead time is zero.

(ii) Re-order level

Meaning
This level lies between
minimum and the maximum
levels in such a way that
before the material ordered
is received into the stores,
there is sufficient quantity
on hand to cover both
normal
and
abnormal
consumption situations. In
other words, it is the level at
which fresh order should be
placed for replenishment of
stock.

Factors

Formula

Maximum
rate
Consumption
Maximum
period

of Re-order
level
=
Maximum re-order period
Re-order Maximum Usage
(or)
= Minimum level +
(Average
rate
of
consumption Average
time to obtain fresh
supplies).

(Re-order period or lead time: Time gap between placing an order and receiving the
stock is known as lead time.)

The Institute of Chartered Accountants of India

2.20

Cost Accounting

(iii) Minimum level

Meaning

Factors

The lowest figure of 1.

inventory balance, which
must be maintained in
hand at all times, so that
there is no stoppage of
production due to non2.
availability of inventory.
3.

Formula

Information
about
maximum consumption
and maximum delivery
period in respect of
each item to determine
its re-order level.
Average
rate
of
consumption for each
inventory item.
Average
delivery
period for each item.
This period can be
calculated
by
averaging
the
maximum
and
minimum period.

Minimum
level
of
inventory = Re-order level
(Average rate of
consumption

average time of inventory

delivery)

(iv) Maximum level

Meaning

Factors

It indicates the maximum 1.

figure
of
inventory
quantity held in stock at
any time.

2.

Formula

The
fixation
of
maximum level of an
inventory item requires
information about itsre-order level. The reorder
level
itself
depends upon its
maximum
rate
of
consumption
and
maximum
delivery
period. It in fact is the
product of maximum
consumption
of
inventory item and its
maximum
delivery
period.
Knowledge

The Institute of Chartered Accountants of India

about

Maximum level of inventory

=
Re-order-level + Reorder quantity
(Minimum consumption
Minimum re-order period)

Material

2.21

minimum consumption
and minimum delivery
period
for
each
inventory item should
also be known.
3.

The determination of
maximum level also
requires the figure of
economic
order
quantity.

4.

Availability of funds,
storage space, nature
of items and their price
per unit are also
important
for
the
fixation of maximum
level.

5.

In the case of imported

materials due to their
irregular supply, the
maximum level should
be high.

(v) Average Inventory Level

Meaning
Average inventory level
is the average stock
held by an organisation

Factors

Formula

Minimum
inventory

level

of Average inventory level =

Maximum
inventory

level

of

Minimum level +

Re-order quantity

1/2 Re-order quantity

or
Maximum level + Minimum level
2

(vi) Danger level

Meaning

Factors

Formula

It is the level at which

normal issues of the

Normal or Average
consumption

Danger level = Average

consumption Lead time for

The Institute of Chartered Accountants of India

2.22

Cost Accounting

raw material inventory

are
stopped
and
emergency issues are
only made.

Lead time (re-order

period) for emergency
purchase

emergency purchases

(vii) Buffer Stock: Some quantity of stock may be kept for contingency to be used in case of
sudden order, such stock is known as buffer stock.

Illustration 3: (Calculation of EOQ)

Calculate the Economic Order Quantity from the following information. Also state the number
of orders to be placed in a year.
Consumption of materials per annum

10,000 kg.

Order placing cost per order

` 50

Cost per kg. of raw materials

`2

Storage costs

8% on average inventory

Solution
EOQ =

2A O

A =

C
Units consumed during year

O =

Ordering cost per order

The Institute of Chartered Accountants of India

Material

C =

Inventory carrying cost per unit per annum.

2 10,000 50
=
2 8
100

EOQ =
=

2.23

2 10,000 50 25
4

2,500 kg.

No. of orders to be placed in a year =

=

Total consumption of materials per annum

EOQ

10,000 kg.
= 4 Orders per year
2,500 kg.

Illustration 4: (Calculation of EOQ and Total variable cost)

(i) Compute E.O.Q. and the total variable cost for the following :
Annual Demand

5,000 units

Unit price

` 20.00

Order cost

`16.00

Storage rate

2% per annum

Interest rate

12% per annum

Obsolescence rate

6% per annum

(ii) Determine the total variable cost that would result for the items if an incorrect price of `
12.80 is used.
Solution:
(i) Carrying cost = Storage rate

2%

Interest Rate

12%

Obsolescence Rate =

6%

Total

20% per annum

C = 20% of ` 20 = ` 4 per unit per annum.

E.O.Q

2AO
C

2 5000 16

40,000 = 200 units

Total variable cost:

Ordering cost =

5000
200

25 orders @ ` 16

The Institute of Chartered Accountants of India

` 400

2.24

Cost Accounting

Carrying cost of average

Inventory

200
2

100 units @ ` 4

Total variable cost

(ii)

` 400

800

If an incorrect price of ` 12.80 is used:

C = 20% of 12.80 = ` 2.56 per unit per annum.
2 5000 16

E.O.Q. =

2.56

= 250 units

Total variable cost:

Ordering cost =

5000
250

20 orders @ ` 16

` 320

320

Carrying cost (of average inventory)

=

250
2

125 units @ ` 2.56

Total variable cost

640

Illustration 5: (Evaluation of existing policy and EOQ)

Anil & Company buys its annual requirement of 36,000 units in 6 installments. Each unit costs
` 1 and the ordering cost is ` 25. The inventory carrying cost is estimated at 20% of unit
value. Find the total annual cost of the existing inventory policy. How much money can be
saved by Economic Order Quantity.
Solution:
(a) Total Annual Cost in Existing Inventory Policy

Ordering cost (6 orders @ ` 25)

Carrying cost of average inventory (36,000 6) = 6,000 units per order
Average inventory = 3,000 units
Carrying cost = 20% of ` 1 3,000 = 3,000 0.20
Total cost
(b) Total Annual Cost in E.O.Q

The Institute of Chartered Accountants of India

(`)
150

600
750

Material

2.25

2 36,000 25
= 3000 units
` 1 20%

EOQ =

(`)

No. of orders = 36,000 3,000 units = 12 orders

Ordering cost (12 ` 25) =
Carrying cost of average inventory (3,000 0.20) 2 =
Total Cost
(A B )
Savings due to EOQ ` (750 600)

300
300
b 600
150

Note : As the units purchase cost of ` 1 does not change in both the computation, the same
has not been considered to arrive at total cost of inventory for the purpose of savings.
Illustration 6: (Evaluation of discount offer and EOQ)
A Company manufactures a special product which requires a component Alpha. The
following particulars are collected for the year 2011:
i)
Annual demand of Alpha
8,000 units
` 200 per order
ii) Cost of placing an order
` 400
iii) Cost per unit of Alpha
iv) Carrying cost p.a.
20%
The company has been offered a quantity discount of 4 % on the purchase of Alpha provided
the order size is 4,000 components at a time.
Required :

i)

Compute the economic order quantity

ii)

Advise whether the quantity discount offer can be accepted.

Solution:

i)

Calculation of Economic Order Quantity

EOQ =

ii)

2AO
=
C

2 8,000 units ` 200

= 200 units
Rs` 400 20 /100

Evaluation of Profitability of Different Options of Order Quantity

(a) When EOQ is ordered
(`)

Purchase Cost

(8,000 units ` 400)

Ordering Cost

[(8,000 units/200 units) `200]

8,000

Carrying Cost

(200 units `400 20/100)

8,000

Total Cost

The Institute of Chartered Accountants of India

32,00,000

32,16,000

2.26

Cost Accounting

(b) When Quantity Discount is accepted

(`)

Purchase Cost
Ordering Cost
Carrying Cost
Total Cost

(8,000 units `384)

[(8,000 units/4000 units) `200]
(4000 units `384 20/100)

30,72,000
400
1,53,600
32,26,000

Advise The total cost of inventory is lower if EOQ is adopted. Hence, the company
is advised not to accept the quantity discount.
Illustration 7: (Calculation of EOQ)
The complete Gardener is deciding on the economic order quantity for two brands of lawn
fertilizer. Super Grow and Natures Own. The following information is collected:
Fertilizer
Annual demand

Super Grow

Natures Own

2,000 bags

1,280 bags

` 1,200
` 480

` 1,400
` 560

Relevant ordering cost per purchase order

Annual relevant carrying cost per bag
Required:
(i)

Compute EOQ for Super Grow and Natures own.

(ii)

For the EOQ, what is the sum of the total annual relevant ordering costs and total annual
relevant carrying costs for Super Grow and Natures own?

(iii) For the EOQ, compute the number of deliveries per year for Super Grow and Natures
own.
Solution:

EOQ =

2AO
C

Where,
A = Annual Demand
O = Ordering cost per order
C = Inventory carrying cost per unit per annum

The Institute of Chartered Accountants of India

Material

(i)

2.27

Calculation of EOQ
Super Grow

EOQ =
=

2 2,000 1,200
480
10,000 or 100 bags

Natures own

2 1,280 1,400
560

EOQ =
=

6,400 or or 80 bags

(ii) Total annual relevant cost = Total annual relevant ordering costs + Total annual relevant
carrying cost
Super Grow
Natures own

= (2,000/100 `1,200) + ( 100 bags

`480)
= ` 24,000 + ` 24,000 = ` 48,000

= (1,280/80 `1,400) + ( 80 bags

` 560)
= ` 22,400 + ` 22,400 = ` 44,800

(iii) Number of deliveries for Super Grow Fertilizer per year

Annual demand for fertilizer bags

EOQ
Super Grow
=

2,000 bags
= 20 orders
100 bags

Natures own

1,280 bags
= 16 orders.
80 bags

Illustration 8: (Calculation of Stock Levels)

Two components, A and B are used as follows :
Normal usage
Maximum usage
Minimum usage
Re-order quantity
Re-order period

50 per week each

75 per week each
25 per week each
A : 300; B : 500
A : 4 to 6 weeks
B : 2 to 4 weeks

Calculate for each component (a) Re-ordering level, (b) Minimum level, (c) Maximum level, (d)
Average stock level.
Solution :
(a) Re-ordering level:

The Institute of Chartered Accountants of India

2.28

Cost Accounting

Maximum usage per week Maximum delivery period.

Re-ordering level for component A = 75 units 6
weeks = 450 units
Re-ordering level for component B = 75 units 4
weeks = 300 units
(b) Minimum level:

Re-order level (Normal usage Average period)

Minimum level for component A = 450 units 50 units 5 weeks = 200 units
Minimum level for component B = 300 units 50 units 3 weeks = 150 units
(c) Maximum level:

Re-order level + Re-order quantity (Min. usage Minimum period)

Maximum level for component A = (450 units + 300 units) (25 units 4 weeks) = 650 units
Maximum level for component B = (300 units + 500 units) (25 units 2 weeks) = 750 units
(d) Average stock level:

(Minimum + Maximum) stock level

Average stock level for component A = (200 units + 650 units) = 425 units.
Average stock level for component B = (150 units + 750 units) = 450 units.
Illustration 9: (Calculation of Stock Levels)
A Company uses three raw materials A, B and C for a particular product for which the
following data apply:
Raw
Material

Usage
per unit
of
Product
(Kgs.)

RePrice
order
per
quantity Kg.
(Kgs.)

Delivery period
(in weeks)

Minimum

Re- Minimum
order
level
level
(Kgs.)
(Kgs)

Average Maximum

10

10,000

0.10

8,000

5,000

0.30

4,750

10,000

0.15

2,000

Weekly production varies from 175 to 225 units, averaging 200 units of the said product. What
would be the following quantities:
(i)
(ii)
(iii)
(iv)

Minimum stock of A,
Maximum stock of B,
Re-order level of C,
Average stock level of A.

Solution

The Institute of Chartered Accountants of India

Material
(i)

2.29

Minimum stock of A

Re-order level (Average rate of consumption Average time required to obtain fresh delivery)
= 8,000 (200 10 2) = 4,000 kgs.
(ii) Maximum stock of B

Re-order level (Minimum consumption Minimum delivery period) + Re-order quantity

= 4,750 (175 4 3) + 5,000
= 9,750 2,100 = 7,650 kgs.
(iii) Re-order level of C

Maximum delivery period Maximum usage

= 4 225 6 = 5,400 kgs.
OR
Re-order level of C
= Minimum stock of C + [Average rate of consumption Average time required to obtain
fresh delivery]
= 2,000 + [(200 6) 3] kgs.
= 5,600 kgs.
(iv) Average stock level of A
= Minimum stock level of A + Re-order quantity of A
= 4,000 + 10,000 = 4,000 + 5,000 = 9,000 kgs.
OR

Average Stock level of A

Minimum stock level of A + Maximum stock level of A
(Refer to working note)
2
4,000 + 16,250
= 10,125 kgs.
2

Working note :

Maximum stock of A = ROL+ ROQ (Minimum consumption Minimum re-order period)

= 8,000 + 10,000 [(175 10) 1]
= 16,250 kgs.
Illustration 10: (Evaluation of discount offer and EOQ)
(a)

EXE Limited has received an offer of quantity discounts on its order of materials as under:
Price per tonne (`)

Tonnes (Nos.)

1,200
1,180
1,160

Less than 500

500 and less than 1,000
1,000 and less than 2,000

The Institute of Chartered Accountants of India

2.30

Cost Accounting
1,140
1,120

2,000 and less than 3,000

3,000 and above.

The annual requirement for the material is 5,000 tonnes. The ordering cost per order is `
1,200 and the stock holding cost is estimated at 20% of material cost per annum. You are
required to compute the most economical purchase level.
(b) What will be your answer to the above question if there are no discounts offered and the
price per tonne is ` 1,500 ?
Solution (a)
Total annual
requirement
(A)

Order size No. of

(Tonne) orders
(q)
A/q

1
5,000 tonnes

2
400

3
12.5

500

10

1,000

2,000

2.5

3,000

1.666

Cost of inventory
APer tonne cost
(`)

Ordering
cost
A/q`1200
(`)
4
5
60,00,000
15,000
(5,000`1200)
59,00,000
12,000
(5,000` 1180)
58,00,000
6,000
(5,000` 1160)
57,00,000
3,000
(5,000` 1140)
56,00,000
2,000
(5,000` 1120)

Carrying cost
Total Cost
p.t.p.a
(4+5+6)
1/2q20% of
(`)
cost p.t.(`)
6
7
48,000 60,63,000
(200 ` 240)
59,000 59,71000
(250 ` 236)
1,16,000 59,22,000
(500 ` 232)
2,28,000 59,31,000
(1,000`228)
3,36,000 59,38,000
(1,500`224)

The above table shows that the total cost of 5,000 units including ordering and carrying cost is
minimum (` 59,22,000) when the order size is 1,000 units. Hence the most economical
purchase level is 1,000 units.

2AO
C

(b) EOQ =
where

A
O
C

is the annual inventory requirement,

is the ordering cost per order and
is the carrying cost per unit per annum.

2 5,000units `1,200
= 200 units
20% `1,500

Illustration 11: (Calculation of Stock Levels and Danger level)

From the details given below, calculate:
(i)

Re-ordering level

The Institute of Chartered Accountants of India

Material
(ii)
(iii)
(iv)

2.31

Maximum level
Minimum level
Danger level.

Re-ordering quantity is to be calculated on the basis of following information:

Cost of placing a purchase order is ` 20
Number of units to be purchased during the year is 5,000
Purchase price per unit inclusive of transportation cost is ` 50
Annual cost of storage per units is ` 5.
Details of lead time
Rate of consumption :

: Average 10 days, Maximum 15 days, Minimum 6 days.

For emergency purchases 4 days.
Average: 15 units per day,
Maximum: 20 units per day.

Solution
Basic Data:

A
(Number of units to be purchased annually)
O
(Ordering cost per order)
C
(Annual cost of storage per unit)
Purchase price per unit inclusive of transportation cost

=
=
=
=

5,000 units
` 20
`5
` 50.

Computations:
Re-ordering level = Maximum usage per period Maximum lead time
(ROL)
= 20 units per day 15 days = 300 units
(ii) Maximum level = ROL + ROQ [Min. rate of consumption Min. lead time]
(Refer to working notes1 and 2)
= 300 units + 200 units [10 units per day 6 days]
=440 units
(iii) Minimum level
= ROL Average rate of consumption Average re-order-period
= 300 units (15 units per day 10 days) =150 units
(iv) Danger level
= Average consumption Lead time for emergency purchases
= 15 units per day 4 days = 60 units
Working Notes:
(i)

1. Minimum rate of consumption per day

Minimum rate of Maximum rate of

+
Av. rate of
consumption
consumption
=
consumption
2
15 units per day =

X units / day + 20 units per day

or
2

The Institute of Chartered Accountants of India

X = 10 units per day.

2.32

Cost Accounting

2. Re-order Quantity (ROQ)

=

2 5,000 units ` 20
5

= 200 units

Illustration 12: (EOQ and calculation of minimum carrying cost)

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

Economic order quantity.

If the minimum lot size to be supplied is 4,000 units, what is the extra cost, the company
has to incur?
(iii) What is the minimum carrying cost, the company has to incur?
Solution
(a) (i)

Economic order quantity:

A (Annual requirement or Component X) = 4,000 units per month 12 months
= 48,000 units
C (Purchase cost p.u.)
= ` 20
O (Ordering cost per order)
= ` 120
i (Holding cost)
= 10% per annum

E.O.Q. =

2AO
C

2 48,000 units ` 120

= 2,400 units
10% ` 20

i
(ii) Extra cost incurred by the company
Total cost
= Total ordering cost + Total carrying cost
(when order size is 4,000 units)

A
1
O + Q (Ci)
Q
2

1
48,000 units
` 120 +
4,000 units 10% ` 20
2
4,000 units
...(a)
= ` 1,440 + ` 4,000 = ` 5,440
1
48,000 units
=
` 120 +
2,400 units 10% ` 20
2
2,400 units
(when order size is 2,400 units)

Total cost

The Institute of Chartered Accountants of India

Material

= ` 2,400 + ` 2,400 = ` 4,800

Extra cost : (a) (b) = ` 5,440 ` 4,800 = ` 640
(incurred by the company)

2.33

...(b)

(iii) Minimum carrying cost :

Carrying cost depends upon the size of the order. It will be minimum on the least
order size. (In this part of the question the two order sizes are 2,400 units and 4,000
units. Here 2,400 units is the least of the two order sizes. At this order size carrying
cost will be minimum.)

The minimum carrying cost in this case can be computed as under :

1
Minimum carrying cost = 2,400 units 10% ` 20 = ` 2,400.
2
Illustration 13: (Calculation of Stock out Cost)
M/s Tyrotubes trades in four wheeler tyres and tubes. It stocks sufficient quantity of tyres of almost
every vehicle. In year end 2011-12, the report of sales manager revealed that
M/s Tyrotubes experienced stock-out of tyres.
The stock-out data is as follows:
Stock-out of Tyres
100
80
50
20
10
0

No. of times
2
5
10
20
30
33

M/s Tyrotubes loses `150 per unit due to stock-out and spends ` 50 per unit on carrying of
inventory.
Determine optimum safest stock level.
Solution:

Safety
Stock
Level
(units)
(1)
100
80
50

Computation of Stock-out and Inventory carrying cost

Stock-out
Probability Stock-out
Expected
Inventory
(units)
(3)
stock-out carrying cost
cost(`)
(2)
(4)=(2) x
cost(`)
(`)
(5)=(3)x(4) (6)=(1)x`50
`150
0
20
50
30

0
0.02
0.02
0.05

The Institute of Chartered Accountants of India

0
3,000
7,500
4,500

0
60
150
225

5,000
4,000

Total cost
(`)
(7)=(5)+(6)
5,000
4,060

2.34

Cost Accounting

20

80
60
30

0.02
0.05
0.10

10

90
70
40
10

0.02
0.05
0.10
0.20

100
80
50
20
10

0.02
0.05
0.10
0.20
0.30

12,000
12,000
9,000
4,500
25,500
13,500
10,500
6,000
1,500
31,500

375
240
450
450
1140
270
525
600
300
1,695

15,000
12,000
7,500
3,000
1,500
39,000

300
600
750
600
450
2,700

2,500

2,875

1,000

2,140

500

2,195

2700

At safety stock level of 20 units, total cost is least i.e ` 2140.

Working Note:
Computation of Probability of Stock-out

Stock-out (units)
Nos of times
Probability

100

80

50

20

10

Total

10

20

30

33

100

0.02

0.05

0.10

0.20

0.30

0.33

1.00

2.6.2 Techniques of Inventory Control: Depending on the type of organization and type of
inventory specific inventory control techniques are adopted. Some of these are:

(1) ABC Analysis: This system exercises discriminating control over different items of stores
classified on the basis of the investment involved. Usually the items are divided into three
categories according to their importance, namely, their value and frequency of replenishment
during a period.
(i) A Category of items consists of only a small percentage i.e., about 10% of the total
items handled by the stores but require heavy investment about 70% of inventory value,
because of their high prices or heavy requirement or both. Items under this category can be
controlled effectively by using a regular system which ensures neither over-stocking nor
shortage of materials for production. Such a system plans its total material requirements by
making budgets. The stocks of materials are controlled by fixing certain levels like maximum
level, minimum level and re-order level.

The Institute of Chartered Accountants of India

Material

2.35

(ii) B Category of items are relatively less important; they may be 20% of the total items of
material handled by stores. The percentage of investment required is about 20% of the total
investment in inventories. In the case these items, as the sum involved is moderate, the same
degree of control as applied in A category of items is not warranted. The orders for the items,
belonging to this category may be placed after reviewing their situation periodically.
(iii) C Category of items do not require much investment; it may be about 10% of total
inventory value but they are nearly 70% of the total items handled by store. For these category
of items, there is no need of exercising constant control. Orders for items in this group may be
placed either after six months or once in a year, after ascertaining consumption requirements.
In this case the objective is to economies on ordering and handling costs.

Illustration 14: (Application of ABC inventory control system)

A factory uses 4,000 varieties of inventory. In terms of inventory holding and inventory usage,
the following information is compiled:
No. of varieties
of inventory
3,875
110
15
4,000

%
96.875
2.750
0.375
100.000

% value of inventory
holding (average)
20
30
50
100

Classify the items of inventory as per ABC analysis with reasons.

Solution
Classification of the items of inventory as per ABC analysis

The Institute of Chartered Accountants of India

% of inventory usage
(in end-product)
5
10
85
100

2.36

1.

Cost Accounting

15 number of varieties of inventory items should be classified as A category items

because of the following reasons :
(i)

Constitute 0.375% of total number of varieties of inventory handled by stores of

factory, which is minimum as per given classification in the table.

(ii) 50% of total use value of inventory holding (average) which is maximum according
to the given table.
(iii) Highest in consumption about 85% of inventory usage (in end-product).
2.

110 number of varieties of inventory items should be classified as B category items

because of the following reasons :
(i)

Constitute 2.750% of total number of varieties of inventory items handled by stores

of factory.

(ii) Requires moderate investment of about 30% of total use value of inventory holding
(average).
(iii) Moderate in consumption about 10% of inventory usage (in endproduct).
3.

3,875 number of varieties of inventory items should be classified as C category items

because of the following reasons:
(i)

Constitute 96.875% of total varieties of inventory items handled by stores of factory.

(ii) Requires about 20% of total use value of inventory holding (average).
(iii) Minimum inventory consumption i.e. about 5% of inventory usage (in end-product).
Illustration 15: (Application of ABC in inventory control system)
From the following details, draw a plan of ABC selective control:
Item

Units

Unit cost (`)

1
2
3
4
5
6
7
8
9
10
11
12

7,000
24,000
1,500
600
38,000
40,000
60,000
3,000
300
29,000
11,500
4,100

5.00
3.00
10.00
22.00
1.50
0.50
0.20
3.50
8.00
0.40
7.10
6.20

The Institute of Chartered Accountants of India

Material

Solution
Statement of Total Cost and Ranking
Item

Units

Unit cost

Total cost

1
2
3
4
5
6
7
8
9
10
11
12

7,000
24,000
1,500
600
38,000
40,000
60,000
3,000
300
29,000
11,500
4,100

5.00
3.00
10.00
22.00
1.50
0.50
0.20
3.50
8.00
0.40
7.10
6.20

35,000
72,000
15,000
13,200
57,000
20,000
12,000
10,500
2,400
11,600
81,650
25,420
3,55,770

%of Total
cost
9.84%
20.24%
4.22%
3.71%
16.02%
5.62%
3.37%
2.95%
0.67%
3.26%
22.95%
7.15%
100.00

Ranking

4
2
7
8
3
6
9
11
12
10
1
5

Basis for selective control (Assumed)

` 50,000 & above

--

A items

` 15,000 to 50000

--

B items

Below ` 15,000

--

C items

On this basis, a plan of A B C selective control is given below:

Ranking

Item Nos.

1
2
3

11
2
5
3
1
12
6
3
4
4
7

Total
4
5
6
7
Total
8
9

% of Total
Items

33.56%

24.02%

The Institute of Chartered Accountants of India

Cost (`)

81,650
72,000
57,000
2,10,650
35,000
25,420
20,000
15,000
95,420
13,200
12,000

% of Total
Cost

Category

59.21%

26.82%

2.37

2.38

Cost Accounting

10
11
12
Total
Grand Total

10
8
9
5
12

42.42%
100

11,600
10,500
2,400
49,700
3,55,770

13.97%
100

(1) Advantages of ABC analysis : The advantages of ABC analysis are the following :

(i)

Continuity in production: It ensures that, without there being any danger of

interruption of production for want of materials or stores, minimum investment will
be made in inventories of stocks of materials or stocks to be carried.

(ii)

Lower cost: The cost of placing orders, receiving goods and maintaining stocks is
minimised specially if the system is coupled with the determination of proper
economic order quantities.

(iii) Less attention required: Management time is saved since attention need be paid
only to some of the items rather than all the items as would be the case if the ABC
system was not in operation.
(iv) Systematic working: With the introduction of the ABC system, much of the work
connected with purchases can be systematized on a routine basis to be handled by
subordinate staff.
(2) HML: In this system inventory items are classified as high price, medium price and low
cost items.
(3) VED: Items are classified as vital, essential and desirable items under this system. This
system is used particularly in spare parts inventory.
(4) FSN: Items are classified as fast moving, slow moving and non-moving items.
(5) GOLF: This system is based on sources of items. These are classified as Government
supply, ordinary supply, local and foreign supply.
(6) SOS: Items are classified as seasonal and off seasonal items.
2.6.3 Two Bin System: Under this system each bin is divided into two parts - one, smaller part,
should stock the quantity equal to the minimum stock or even the re-ordering level, and the other to
keep the remaining quantity. Issues are made out of the larger part; but as soon as it becomes
necessary to use quantity out of the smaller part of the bin, fresh order is placed. Two Bin System
is supplemental to the record of respective quantities on the bin card and the stores ledger card.

2.6.4 Establishment of system of budgets: To control investment in the inventories, it is

necessary to know in advance about the inventories requirement during a specific period
usually a year. The exact quantity of various types of inventories and the time when they
would be required can be known by studying carefully production plans and production

The Institute of Chartered Accountants of India

Material

2.39

schedules. Based on this, inventories requirement budget can be prepared. Such a budget will
discourage the unnecessary investment in inventories.

2.6.5 Use of perpetual inventory records and continuous stock verification: Perpetual
inventory represents a system of records maintained by the stores department. It in fact
comprises: (i) Bin Cards, and (ii) Stores Ledger.
The success of perpetual inventory depends upon the following:
(a)

The Stores Ledger(showing quantities and amount of each item).

(b)

Stock Control cards (or Bin Cards).

(c)

Reconciling the quantity balances shown by (a) & (b) above.

(d)

Checking the physical balances of a number of items every day systematically and by
rotation.

(e)

Explaining promptly the causes of discrepancies, if any, between physical balances and
book figures.

(f)

Making corrective entries where called for after step (e) and

(g)

Removing the causes of the discrepancies referred to in step (e)

Advantages of perpetual inventory: The main advantages of perpetual inventory are as

follows:

(1)

Physical stocks can be counted and book balances adjusted as and when desired
without waiting for the entire stock-taking to be done.

(2)

Quick compilation of Profit and Loss Account (for interim period) due to prompt
availability of stock figures.

(3)

Discrepancies are easily located and thus corrective action can be promptly taken to
avoid their recurrence.

(4)

A systematic review of the perpetual inventory reveals the existence of surplus,

dormant, obsolete and slow-moving materials, so that remedial measures may be taken
in time.

(5)

Fixation of the various stock levels and checking of actual balances in hand with these
levels assist the Store keeper in maintaining stocks within limits and in initiating
purchase requisitions for correct quantity at the proper time.

Continuous stock verification The checking of physical inventory is an essential feature of

every sound system of material control. Such a checking may be periodical or continuous.
Moreover, in the case of periodical checking there is the problem of finding an adequately
trained contingent. It is likely to be drawn from different departments where stock-taking is not
the normal work and they are apt to discharge such temporary duties somewhat perfunctorily.
The element of surprise, that is essential for effective control is wholly absent in the system.

The Institute of Chartered Accountants of India

2.40

Cost Accounting

Then if there are stock discrepancies, they remain undetected until the end of the period.
Often, the discrepancies are not corrected.
The system of continuous stock-taking consists of counting and verifying the number of items
daily throughout the year so that during the year all items of stores are covered three or four
times. The stock verifiers are independent of the stores, and the stores staffs have no
foreknowledge as to the particular items that would be checked on any particular day. But it
must be seen that each item is checked a number of times in a year.
Advantages of continuous stock-taking: The advantages of continuous stock-taking are:

1.

Closure of normal functioning is not necessary.

2.

Stock discrepancies are likely to be brought to the notice and corrected much earlier
than under the annual stock-taking system.

3.

The system generally has a sobering influence on the stores staff because of the
element of surprise present therein.

4.

The movement of stores items can be watched more closely by the stores auditor so
that chances of obsolescence buying are reduced.

5.

Final Accounts can be ready quickly. Interim accounts are possible quite conveniently.

Disadvantages: Annual stock-taking, however, has certain inherent shortcomings which tend
to detract from the usefulness of such physical verification. For instance, since all the items
have to be covered in a given number of days, either the production department has to be shut
down during those days to enable thorough checking of stock or else the verification must be
of limited character.

2.6.7 Review of slow and non-moving items: Sometimes, due to high value of slow
moving and non-moving raw materials, it appears that the concern has blocked huge sum of
money unnecessarily in raw materials. To overcome this problem, it is necessary to disposeoff these as early as possible or make arrangements for their exchange with the inventories
required by the concern. Besides this no new requisition should be made for the purchase of
slow moving items, till the existing stock is exhausted. Computation of inventory turnover ratio
may help in identifying slow moving items.
2.6.8 Use of control ratios
(i) Input Output Ratio: Inventory control can also be exercised by the use of input output
ratio analysis. Input-output ratio is the ratio of the quantity of input of material to production
and the standard material content of the actual output.

This type of ratio analysis enables comparison of actual consumption and standard
consumption, thus indicating whether the usage of material is favourable or adverse.
(ii) Inventory Turnover Ratio: Computation of inventory turnover ratios for different items of
material and comparison of the turnover rates provides a useful guidance for measuring
inventory performance. High inventory turnover ratio indicates that the material in the question

The Institute of Chartered Accountants of India

Material

2.41

is a fast moving one. A low turnover ratio indicates over-investment and locking up of the
working capital in inventories. Inventory turnover ratio may be calculated by using the
following formulae:Inventory Turnover Ratio =
Average stock

Cost of materials consumed during t he period

Cost of a verage stock held during t he period

1/2 (opening stock + closing stock)

Average no. of days of Inventory holding =

360 days/ 12 months

Inventory Turnover Ratio

By comparing the number of days in the case of two different materials, it is possible to know
which is fast moving and which is slow moving. On this basis, attempt should be made to
reduce the amount of capital locked up, and prevent over-stocking of the slow moving items.
Illustration 16: (Calculation of inventory turnover ratio)
The following data are available in respect of material X for the year ended 31st March, 2011.
(`)
90,000

Opening stock
Purchases during the year

2,70,000

Closing stock

1,10,000

Calculate:
(i)

Inventory turnover ratio, and

(ii)

The number of days for which the average inventory is held.

Solution

Inventory turnover ratio

(Refer to working note)

Cost of stock of raw material consumed

Average stock of raw material
` 2,50,000
= 2.5
=
` 1,00,000
=

Average number of days for which

the average inventory is held

365
365days
= 146 days
=
Inventory turnover ratio
2.5

Working Note :

Opening stock of raw material

Add: Material purchases during the year

The Institute of Chartered Accountants of India

(`)
90,000
2,70,000

2.42

Cost Accounting

Less: Closing stock of raw material

Cost of stock of raw material consumed

1,10,000
2,50,000

Illustration 17: (Calculation of inventory turnover ratio)

From the following data for the year ended 31st December, 2011, calculate the inventory
turnover ratio of the two items and put forward your comments on them.

Opening stock 1.1.2011

Purchase during the year
Closing stock 31.12.2011
Solution

Material A

Material B

10,000
52,000
6,000

9,000
27,000
11,000

First of all it is necessary to find out the material consumed:

Cost of materials consumed
Opening stock
Add: Purchases
Less: Closing stock
Materials consumed
Average inventory: (Opening Stock + Closing Stock) 2
Inventory Turnover ratio: (Consumption Average inventory)
Inventory Turnover (Number of Days in a year/IT ratio)

Material A
`
10,000
52,000
62,000
6,000
56,000
8,000
7 times
52 days

Material B
`
9,000
27,000
36,000
11,000
25,000
10,000
2.5 times
146 days

Comments: Material A is more fast moving than Material B.

2.7 Material Issue Procedure

Issue of material must not be made except under properly authorised requisition slip; usually it
is the foreman of a department who has the authority to draw materials from the store. Issue
of material must be made on the basis of first in first out, that is, out of the earliest lot on hand.
If care is not exercised in this regard, quality of earliest lot of material may deteriorate for
having been kept for a long period.
Material requisition note : It is the voucher of the authority as regards issue of materials for
use in the factory or in any of its departments. After receipt of material requisition slip store
keeper ensures that requisition is properly authorized and requisitioned quantity is within the
quantity specified in bill of materials. After satisfied with the documents, store keeper issue
materials and keep one copy of based materials and record the transaction in the records
maintained by the stores department.
Transfer of material: The surplus material arising on a job or other units of production may
sometime be unsuitable for transfer to Stores because of its bulk, heavy weight, brittleness or

The Institute of Chartered Accountants of India

Material

2.43

some such reason. It may, however, be possible to find some alternative use for such
materials by transferring it to some other job instead of returning it to the Store Room.
It must be stressed that generally transfer of material from one job to another is irregular, if not
improper, in so far it is not conducive to correct allocation and control of material cost of jobs
or other units of production. It is only in the circumstances envisaged above that such direct
transfer should be made, at the time of material transfer a material transfer note should be
made in duplicate, the disposition of the copies of this note being are as follows :
Material Transfer Note

Cost Department

Department Making Transfer

No copy is required for the Store as no entry in the stores records would be called for. The
Cost Department would use its copy for the purpose of making the necessary entries in the
cost ledger accounts for the jobs affected.
The form of the Material Transfer Note is shown below:
Material Transfer Note

From Job No. ..................................

No. ....................................

To Job No. ........................................

Date .................................

Item No.

Particulars

Transferred by

Rate
`

Amount
`

Received by ....................................
Job Ledger Clerk

Return of material: Sometimes, it is not possible before hand to make any precise estimate of
the material requirements or units of production. Besides, at times due to some technical or
other difficulty, it is not practicable to measure exactly the quantity of material required by a
department. In either case, material may have to be issued from stores in bulk, often in excess
of the actual quantity required. Where such a condition exists, it is of the utmost importance
from the point of view of materials control that any surplus material left over on the completion
of a job should be promptly hand over to the storekeeper for safe and proper custody.

Unless this is done, the surplus material may be misappropriated or misapplied to some
purpose, other than that for which it was intended. The material cost of the job against which

The Institute of Chartered Accountants of India

2.44

Cost Accounting

the excess material was originally drawn in that case, would be overstated unless the job is
given credit for the surplus arising thereon.
The surplus material, when it is returned to the storeroom, should be accompanied by a
document known either as a Shop Credit Note or alternatively as a Stores Debit Note. This
document should be made out, by the department returning the surplus material and it should
be in triplicate to be used as follows:
Shop Credit Note

Store Room

Cost Department

Department Returning it

The form of Shop Credit Note is given below:

Shop Credit Note

Job No. ......................................

No. ........................

Department ............................

Date ......................

Item No.

Store-keeper

Particulars

Qnty.

Rate

S.L. Clerk

Amount

Foreman of the Returning

Department

2.8 Valuation of Material Issues

Materials issued from stores should be priced at the value at which they are carried in stock.
But there can be a situation where the material may have been purchased at different times
and at different prices with varying discounts, taxes etc. Because of this the problem arises as
to how the material issues to production are to be valued. There are several methods for
tackling this situation. The cost accountant should select the proper method based on
following factors:
1.

The frequency of purchases, price fluctuations and its range.

2.

The frequency of issue of materials, relative quantity etc.

3.

Nature of cost accounting system.

4.

The nature of business and type of production process.

5.

Management policy relating to valuation of closing stock.

The Institute of Chartered Accountants of India

Material

2.45

Several methods of pricing material issues have been evolved in an attempt to satisfactorily
answer the problem. These methods may be grouped and explained as follows:

2.8.1 Cost Price Methods:

(a)

Specific price method.

(b)

First-in First-out method.

(c)

Last-in-First-out method.

(d)

Base stock method.

2.8.2 Average Price Methods:

(e)

Simple average price method.

(f)

Weighted average price method.

(g)

Periodic simple average price method.

(h)

Periodic weighted average price method.

(i)

Moving simple average price method.

(j)

Moving weighted average price method.

2.8.3 Market Price Methods:

(k)

Replacement price method.

(l)

Realisable price method.

2.8.4 Notional Price Methods:

(m)

Standard price method.

(n)

Inflated price methods.

(o)

Re-use Price Method.

We may now briefly discuss all the above methods:

(a) Specific Price Method
Meaning

Suitability

This method is useful, specially when To use this method, it is necessary to

materials are purchased for a specific job store each lot of material separately and
or work order, and as such these materials maintain its separate account.
are issued subsequently to that specific job
or work order at the price at which they
were purchased.

The Institute of Chartered Accountants of India

2.46

Cost Accounting

Advantages and disadvantage

Advantages

Disadvantages

The cost of materials issued for

production purposes to specific jobs
represent actual and correct costs.
This method is best suited for nonstandard and specific products.

This method is difficult to operate,

specially when purchases and issues
are numerous.

(b) First-in-First out Method (FIFO)

Meaning

Suitability

It is a method of pricing the issues of

materials, in the order in which they
are purchased. In other words, the
materials are issued in the order in
which they arrive in the store or the
items longest in stock are issued first.
Thus each issue of material only
recovers the purchase price which
does not reflect the current market
price.

This method is considered suitable in times of

falling price because the material cost charged to
production will be high while the replacement
cost of materials will be low. But, in the case of
rising prices, if this method is adopted, the
charge to production will be low as compared to
the replacement cost of materials. Consequently,
it would be difficult to purchase the same volume
of material (as in the current period) in future
without having additional capital resources.

Advantages and disadvantages

Advantages

Disadvantages

It is simple to understand and

easy to operate.
Material cost charged to
production represents actual cost
with which the cost of production
should have been charged.

If the prices fluctuate frequently, this method

may lead to clerical error.
Since each issue of material to production is
related to a specific purchase price, the costs
charged to the same job are likely to show a
variation from period to period.

In the case of falling prices, the

use of this method gives better
results.

In the case of rising prices, the real profits of

the concern being low, they may be
inadequate to meet the concerns demand to
purchase raw materials at the ruling price.

Closing stock of material will be

represented very closely at
current market price.

The Institute of Chartered Accountants of India

Material

2.47

The application of FIFO method is illustrated below:

Material Received and Issued

Lot
No.
1.
2.
3.
4.
5.

Date
July 3
July 13
July 23
August 5
August 6
July 8
July 12
July 22
July 25

Quantity
Kg.
600
800
600
400
1200

August 8

Lot
No.

400 Kgs. out of (1)

200 Kgs. out of (1)
600 Kgs. out of (2)
200 Kgs. out of (2)
200 Kgs. out of (3)
400 Kgs. out of (3)
400 Kgs. out of (4)
200 Kgs. out of (5)

Rate
(`)
1.00
1.20
0.90
1.10
0.80
1.00
1.00
1.20
1.20
0.90
0.90
1.10
0.80

Amount
(`)
600.00
960.00
540.00
440.00
960.00
400.00
200.00
720.00
240.00
180.00
360.00
440.00
160.00

The stock in hand after 8th August will be 1,000 Kgs. This will be out of lot number (5)
and its value will be ` 800, i.e., @ ` 0.80 per Kg.
(c) Last-in-First out method (LIFO)
Meaning

It is a method of pricing the issues of

materials. This method is based on the
assumption that the items of the last batch
(lot) purchased are the first to be issued.
Therefore, under this method the prices of
the last batch (lot) are used for pricing the
issues, until it is exhausted, and so on. If
however, the quantity of issue is more than
the quantity of the latest lot than earlier
(lot) and its price will also be taken into
consideration.

Suitability

During inflationary period or period of

rising prices, the use of LIFO would help
to ensure that the cost of production
determined on the above basis is
approximately the current one. This
method is also useful specially when
there is a feeling that due to the use of
FIFO or average methods, the profits
shown and tax paid are too high.

Advantages and disadvantages

Advantages

The cost of materials issued will

The Institute of Chartered Accountants of India

Disadvantages

Calculation under LIFO system becomes

2.48

Cost Accounting

be either nearer to and or will

reflect the current market price.
Thus, the cost of goods produced
will be related to the trend of the
market price of materials. Such a
trend in price of materials enables
the matching of cost of production
with current sales revenues.
The use of the method during the
period of rising prices does not
reflect undue high profit in the
income statement as it was under
the first-in-first-out or average
method. In fact, the profit shown
here is relatively lower because
the cost of production takes into
account the rising trend of material
prices.
In the case of falling prices profit
tends to rise due to lower material
cost, yet the finished products
appear to be more competitive and
are at market price.
Over a period, the use of LIFO
helps to iron out the fluctuations in
profits.
In the period of inflation LIFO will
tend to show the correct profit and
thus avoid paying undue taxes to
some extent.

complicated and cumbersome when

frequent purchases are made at highly
fluctuating rates.

Costs of different similar batches of

production carried on at the same time
may differ a great deal.

In time of falling prices, there will be need

for writing off stock value considerably to
stick to the principle of stock valuation,
i.e., the cost or the market price whichever
is lower.
This method of valuation of material is not
acceptable to the income tax authorities.

(d) Base Stock Method

Meaning

Suitability

Minimum quantity of stock under this

method is always held at a fixed price
as reserve in the stock, to meet a state
of emergency, if it arises. This
minimum stock is known as base stock
and is valued at a price at which the
first lot of materials is received and
remains unaffected by subsequent

This method of valuing inventory than a

method of valuing issues because, with the
base of stock valued at the original cost some
other method of valuing issues should be
adopted. The quantity in excess of the base
stock may be valued either on the FIFO or
LIFO basis. This method is not an independent

The Institute of Chartered Accountants of India

Material

price fluctuations.

2.49

method as it uses FIFO or LIFO. Its advantages and disadvantages therefore will depend
upon the use of the other method viz., FIFO or
LIFO.

Illustration 18: (Treatment of shortage in stock taking)

AT Ltd. furnishes the following store transactions for September, 2011 :
1-9-11

Opening balance

25 units value ` 162.50

4-9-11

Issues Req. No. 85

8 units

6-9-11

Receipts from B & Co. GRN No. 26

50 units @ ` 5.75 per unit

7-9-11

Issues Req. No. 97

12 units

10-9-11

Return to B & Co.

10 units

12-9-11

Issues Req. No. 108

15 units

13-9-11

Issues Req. No. 110

20 units

15-9-11

Receipts from M & Co. GRN. No. 33

25 units @ ` 6.10 per unit

17-9-11

Issues Req. No. 121

10 units

19-9-11

Received replacement from B & Co.

GRN No. 38

20-9-11

Returned from department, material of

M & Co. MRR No. 4

22-9-11

10 units
5 units

Transfer from Job 182 to Job 187 in the

dept. MTR 6

5 units

26-9-11

Issues Req. No. 146

10 units

29-9-11

Transfer from Dept. A to Dept. B MTR 10

5 units

30-9-11

Shortage in stock taking

2 units

Write up the priced stores ledger on FIFO method and discuss how would you treat the
shortage in stock taking.

The Institute of Chartered Accountants of India

25

10

7-9-11

10-9-11

12-9-11

13-9-11
15-9-11 33

17-9-11
19-9-11 38

20-9-11 4

26-9-11

30-9-11

50

26

1-9-11
4-9-11
6-9-11

Qty.
Units
3

GRN No.
MRR No.
2

Date

Solution :

The Institute of Chartered Accountants of India

5.75

5.75

6.10

5.75

Rate
(`)
4

28.75

57.50

152.50

287.50

Amount
(`)
5

Shortage

146

121

110

108

Nil

97

85

Requisition No.
6

5
5
2

10

5
10
20

10

12

Qty.
Units
7

5.75
6.10
6.10

5.75

6.50
5.75
5.75

5.75

6.50

6.50

Rate
(`)
8

59.25
12.20

57.50

90
115

57.50

78

52

Amount
(`)
9

30
10
10
25
25
25
10
5
25
10
20
10
18
10

25
17
17
50
5
50
5
40

Qty.
Units
10

Stores Ledger of AT Ltd. for the month of September, 2011 (FIFO Method)
RECEIPT
ISSUE

5.75
5.75
5.75
6.10
6.10
6.10
5.75
5.75
6.10
7.75
6.10
5.75
6.10
5.75

6.50
6.50
6.50
5.75
6.50
5.75
6.50
5.75

Rate
(`)
11

BALANCE

167.30

179.50

258.75

210.00

210.00
152.50

172.50
57.50

262.00

320.00

398.00

162.50
110.50

Amount
(`)
12

2.50
Cost Accounting

Material

2.51

Working Notes:
1.

The material received as replacement from vendor is treated as fresh supply.

2.

In the absence of information the price of the material received from within on 20-9-11
has been taken as the price of the earlier issue made on 17-9-11. In FIFO method
physical flow of the material is irrelevant for pricing the issues.

3.

The issue of material on 26-9-11 is made out of the material received from within.

4.

The entries for transfer of material from one job and department to other on 22-9-11 and
29-9-11 are book entries for adjusting the cost of respective jobs and as such they have
not been shown in the stores ledger account.

5.

The material found short as a result of stock taking has been written off.

Illustration 19: (Calculation of value of materials consumed and stock)

The following information is provided by Sunrise Industries for the fortnight of April, 2011:
Material Exe :
Stock on 1-4-2011 100 units at ` 5 per unit.
Purchases
5-4-11
8-4-11
12-4-11

300
500
600

units
units
units

Issues
6-4-11
10-4-11
14-4-11

250
400
500

units
units
units

at ` 6
at ` 7
at ` 8

Required :
(A) Calculate using FIFO and LIFO methods of pricing issues :
(a) the value of materials consumed during the period
(b) the value of stock of materials on 15-4-11.
(B) Explain why the figures in (a) and (b) in part A of this question are different under the two
methods of pricing of material issues used. You need not draw up the Stores Ledgers.
Solution
(A) (a) Value of Material Exe consumed during the period
1-4-11 to 15-4-11 by using FIFO method.
Date
1-4-11
5-4-11

Description Units
Opening balance
Purchased

The Institute of Chartered Accountants of India

Qty.

Rate

Amount

(`)

(`)

(`)

100
300

5
6

500
1,800

2.52

Cost Accounting

6-4-11
8-4-11
10-4-11
12-4-11
14-4-11
15-4-11

Issued
Purchased
Issued
Purchased
Issued
Balance

100
150

1,400

500
150
250

3,500

2,650

600
250
250

8
7

4,800

350

2,800

3,750

Total value of material Exe consumed during the period under FIFO method comes to (`
1,400 + ` 2,650 + ` 3,750) ` 7,800 and balance on 15-4-11 is of ` 2,800.
Value of Material Exe consumed during the period
1-4-11 to 15-4-11 by using LIFO method
Date

1-4-11
5-4-11
6-4-11
8-4-11
10-4-11
12-4-11
14-4-11
15-4-11

Description

Opening balance
Purchased
Issued
Purchased
Issued
Purchased
Issued
Balance

Qty.
Units

Rate

Amount

(`)

(`)

100
300
250
500
400
600
500
350

5
6
6
7
7
8
8

500
1,800
1,500
3,500
2,800
4,800
4,000
2,300*

Total value of material Exe issued under LIFO method comes to (` 1,500 + ` 2,800 + `
4,000) ` 8,300.
*The balance 350 units on 15-4-11 of ` 2,300, relates to opening balance on 1-4-11 and
purchases made on 5-4-11, 8-4-11 and 12-4-11. (100 units @ ` 5, 50 units @ ` 6, 100
units @ ` 7 and 100 units @ ` 8).
(b) As shown in (a) above, the value of stock of materials on 15-4-11:
Under FIFO method ` 2,800
Under LIFO method ` 2,300
(B) Total value of material Exe issued to production under FIFO and LIFO methods comes to
` 7,800 and ` 8,300 respectively. The value of closing stock of material Exe on 15-4-11
under FIFO and LIFO methods comes to ` 2,800 and ` 2,300 respectively.

The Institute of Chartered Accountants of India

Material

2.53

The reasons for the difference of ` 500 (` 8,300 ` 7,800) as shown by the following
table in the value of material Exe, issued to production under FIFO and LIFO are as
follows:
Date

Quantity
Issued

Value
FIFO

Total

Value
LIFO

Total

(Units)
(`)
(`)
(`)
(`)
6-4-11
250
1,400
1,500
10-4-11
400
2,650
2,800
14-4-11
500
3,750
7,800
4,000
8,300
1. On 6-4-11, 250 units were issued to production. Under FIFO their value comes to
` 1,400 (100 units ` 5 + 150 units ` 6) and under LIFO ` 1,500 (250 ` 6).
Hence, ` 100 was more charged to production under LIFO.

2.

On 10-4-11, 400 units were issued to production. Under FIFO their value comes to
` 2,650 (150 ` 6 + 250 ` 7) and under LIFO ` 2,800 (400 ` 7). Hence, ` 150
was more charged to production under LIFO.

3.

On 14-4-11, 500 units were issued to production. Under FIFO their value comes to
` 3,750 (250 ` 7 + 250 ` 8) and under LIFO ` 4,000 (500 ` 8). Hence, ` 250
was more charged to production under LIFO.

Thus the total excess amount charged to production under LIFO comes to ` 500.
The reasons for the difference of ` 500 (` 2,800 ` 2,300) in the value of 350 units of Closing
Stock of material Exe under FIFO and LIFO are as follows :
1.

In the case of FIFO, all the 350 units of the closing stock belongs to the purchase of
material made on 12-4-11, whereas under LIFO these units were from opening balance
and purchases made on 5-4-11, 8-4-11 and 12-4-11.

2.

Due to different purchase price paid by the concern on different days of purchase, the value
of closing stock differed under FIFO and LIFO. Under FIFO 350 units of closing stock were
valued @ ` 8 p.u. Whereas under LIFO first 100 units were valued @ ` 5 p.u., next 50 units
@ ` 6 p.u., next 100 units @ ` 7 p.u. and last 100 units @ ` 8 p.u.
Thus under FIFO, the value of closing stock increased by ` 500.

Illustration 20: (Methods of pricing of materials)

The following transactions in respect of material Y occurred during the six months ended 30th
June, 2011:
Month
January
February

Purchase (units)
200
300

The Institute of Chartered Accountants of India

Price per unit

(`)
25
24

Issued
units
Nil
250

2.54

Cost Accounting

March
April
May
June

425
475
500
600

26
23
25
20

300
550
800
400

Required :
(a) The Chief Accountant argues that the value of closing stock remains the same no matter
which method of pricing of material issues is used. Do you agree? Why or why not?
Detailed stores ledgers are not required.
(b) When and why would you recommend the LIFO method of pricing material issues?
Solution

(a) The Closing Stock at the end of six months period i.e., on 30th June, 2011 will be 200
units, whereas up to the end of May 2011, total purchases coincide with the total issues i.e.,
1,900 units. It means that at the end of May 2011, there was no closing stock. In the month of
June 2011, 600 units were purchased out of which 400 units were issued. Since there was
only one purchase and one issue in the month of June, 2011 and there was no opening stock
on 1st June 2011, the Closing Stock of 200 units is to be valued at ` 20 per unit.
In view of this, the argument of the Chief Accountant appears to be correct. Where there is
only one purchase and one issue in a month with no opening stock, the method of pricing of
material issues becomes irrelevant. Therefore, in the given case one should agree with the
argument of the Chief Accountant that the value of Closing Stock remains the same no matter
which method of pricing the issue is used.
It may, however, be noted that the argument of Chief Accountant would not stand if one finds
the value of the Closing Stock at the end of each month.
(b) LIFO method has an edge over FIFO or any other method of pricing material issues due
to the following advantages :
(i)

The cost of the materials issued will be either nearer or will reflect the current market
price. Thus, the cost of goods produced will be related to the trend of the market price of
materials. Such a trend in price of materials enables the matching of cost of production
with current sales revenues.

(ii) The use of the method during the period of rising prices does not reflect undue high profit
in the income statement, as it was under the first-in-first-out or average method. In fact,
the profit shown here is relatively lower because the cost of production takes into account
the rising trend of material prices.
(iii) In the case of falling prices, profit tends to rise due to lower material cost, yet the finished
products appear to be more competitive and are at market price.

The Institute of Chartered Accountants of India

Material

2.55

(iv) During the period of inflation, LIFO will tend to show the correct profit and thus, avoid
paying undue taxes to some extent.
(e) Simple Average Price Method
Meaning

Under this method, materials issued are valued 1.

at average price, which is calculated by dividing
the total of all units rate by the number of unit
rate.
2.

Material issue price =

Suitability

When the materials are received in

uniform lots of similar quantity,
otherwise, it will give wrong results.
When purchase prices do not fluctuate
considerably.

Total of unit prices of each purchase

Total number of purchases

Advantage:

1.

It is simple to understand and easy to operate.

Disadvantages:

1.

Materials issue cost does not represent actual cost price. Since the materials are issued
at a price obtained by averaging cost prices, a profit or loss may arise from such type of
pricing.

2.

In case the prices of material fluctuate considerably, this method will give incorrect
results.

3.

The prices of materials issues used are determined by averaging prices of purchases
without giving consideration to the quantity. Such a price determination is unscientific.

(f)

Weighted Average Price Method

Meaning

Suitability

This method gives due weights to quantities This method is useful in case where quality of
purchased and the purchase price, while, material purchased under different lot varies
determining the issue price. The average
issue price here is calculated by dividing the
total cost of materials in the stock by total
quantity of materials prior to each issue.

The Institute of Chartered Accountants of India

2.56

Cost Accounting

Advantages and disadvantages

Advantages

Disadvantages

It smoothens the price fluctuations if at all

it is there due to material purchases.

Material cost does not represent actual

cost price and therefore, a profit or loss
will arise out of such a pricing method.

Issue prices need not be calculated for each

issue unless new lot of materials is
received.

It may be difficult to compute since every

men lot received would require
recomputation of issue prices.

(g) Periodic Simple Average Price Method

Meaning

Suitability

This method is similar to Simple Average

When both quality and rate are different in
Price Method except that the average price is
different lot.
calculated at the end of the concerned period.
In other words, the price paid during the
period for different lots of materials
purchased are added up and the total is
divided by the number of purchases made
during the period. The rate so computed is
then used to price all the issues made during
the period, and also for valuing the closing
inventory of the period.
Advantages and disadvantages
Advantages

Disadvantages

It is simple to operate, as it avoids

calculation of issue price after every
receipt.

This method can usefully be employed in

costing continuous processes where each
individual order is absorbed into the
general cost of producing large quantities
of articles.

The Institute of Chartered Accountants of India

This method cannot be applied in jobbing

industry where each individual job order is
to be priced at each stage of its
completion.
This method is unscientific as it does not
take into consideration the quantities
purchased at different prices.

This method also suffers from all those

disadvantages of simple average cost
method.

Material

2.57

(h) Periodic Weighted Average Price Method

Meaning: This method is like weighted average price method, except that the calculations of
issue prices are made periodically (say, a month). The rate so arrived is used for the issues
made during that period and also for valuing the inventory at the end of the period.
Advantage:

1.

This method is superior to the periodic simple average price method as it takes into
account the quantities also.

2.

It overcomes or evens out the effect of fluctuations.

3.

In addition to above, the method also possesses all the advantages of the simple
weighted average price method.

Disadvantage:

This method is not suitable for job costing because each job is to be priced at each stage of
completion.
(i) Moving Simple Average Price Method
Meaning: Under this method, the rate for material issues is determined by dividing the total of
the periodic simple average prices of a given number of periods by the numbers of periods.
For determining the moving simple average price, it is necessary to fix up first period to be
taken for determining the average.
Advantage: This method evens out price fluctuations over a longer period, thus stabilising the
charges to work-in-progress. Thus the cost of production will be stable to a significant extent.
Disadvantage: A profit or loss arises by the use of moving simple average cost.
(j) Moving Weighted Average Price Method
Meaning: Under this method, the issue, rate is calculated by dividing the total of the periodic
weighted average price of a given number of periods by the number of periods.
(k) Replacement Price Method
Meaning

Suitability

Replacement price is defined as the price at

which it is possible to purchase an item,
identical to that which is being replaced or
revalued. Under this method, materials issued
are valued at the replacement cost of the items.
This method pre-supposes the determination of
the replacement cost of materials at the time of

This method is useful to determine true cost of

production and to value material issues in
periods of rising prices, because the cost of
material considered in cost of production would
be able to replace the materials at the increased
price.

The Institute of Chartered Accountants of India

2.58

Cost Accounting

each issue; viz., the cost at which identical

materials could be currently purchased. The
product cost under this method is at current
market price, which is the main objective of the
replacement price method.
Advantage: Product cost reflects the current market prices and it can be compared with the selling
price.
Disadvantage: The use of the method requires the determination of market price of material
before each issue of material. Such a requirement creates problems.
(l) Realisable Price Method
Meaning: Realisable price means a price at which the material to be issued can be sold in the
market. This price may be more or may be less than the cost price at which it was originally
purchased. Like replacement price method, the stores ledger would show profit or loss in this
method too.
(m) Standard Price Method: Under this method, materials are priced at some predetermined rate
or standard price irrespective of the actual purchase cost of the materials. Standard cost is usually
fixed after taking into consideration the following factors:

(i)

Current prices,

(ii)

Anticipated market trends, and

(iii) Discount available and transport charges etc.

Standard prices are fixed for each material and the requisitions are priced at the standard price.
This method is useful for controlling material cost and determining the efficiency of purchase
department. In the case of highly fluctuating prices of materials, it is difficult to fix their standard
cost on long-term basis.
Advantages

Disadvantages

The use of the standard price method

simplifies the task of valuing issues of
materials.

The use of standard price does not reflect

the market price and thus results in a profit
or loss.

It facilitates the control of material cost and

the task of judging the efficiency of purchase
department.

The fixation of standard price becomes

difficult when prices fluctuate frequently

It reduces the clerical work.

The Institute of Chartered Accountants of India

Material

2.59

Illustration 21: (Evaluation of different methods)

The following information is extracted from the Stores Ledger:
Material X
Opening Stock

Nil

Purchases :
Jan. 1

100 @ ` 1 per unit

Jan. 20

100 @ ` 2 per unit

Issues :
Jan. 22

60 for Job W 16

Jan. 23

60 for Job W 17

Complete the receipts and issues valuation by adopting the First-In-First-Out, Last-In-First-Out
and the Weighted Average Method. Tabulate the values allocated to Job W 16, Job W 17 and
the closing stock under the methods aforesaid and discuss from different points of view which
method you would prefer.
Solution

From the point of view of cost of material charged to each job, it is minimum under FIFO and
maximum under LIFO (Refer to Tables). During the period of rising prices, the use of FIFO
give rise to high profits and that of LIFO low profits. In the case of weighted average there is
no significant adverse or favourable effect on the cost of material as well as on profits.
From the point of view of valuation of closing stock it is apparent from the above statement
that it is maximum under FIFO, moderate under weighted average and minimum under LIFO.
It is clear from the Tables that the use of weighted average evens out the fluctuations in the
prices. Under this method, the cost of materials issued to the jobs and the cost of material in
hands reflects greater uniformity than under FIFO and LIFO. Thus from different points of
view, weighted average method is preferred over LIFO and FIFO.

The Institute of Chartered Accountants of India

 The Institute of Chartered Accountants of India

Purchase
Purchase

Issue to
Job W 16
Issue to
Job W 17

Jan. 1
Jan. 20

Jan. 22

Jan. 23

Particulars

Issue to Job W 17

Jan. 23

Date

Issue to Job W 16

Jan. 22

1
2

100
200

Receipts
Rate
Value
(`)
(`)

40
20

60

Units
No.

1
2

Issues
Rate
(`)

40
40

60

Value
(`)

80

100
100
100
40
100

Units
No.

1
1
2
1
2

Balance
Rate
(`)

100
100

1
2

100
200

40
20

60

2
1

80
20

120

100
100
100
100
40
80

1
1
2
1
2
1

Statement of receipts and issues by adopting Last-In-First-Out method

Receipts
Issues
Balance
Units
Rate
Value Units
Rate
Value
Units
Rate
No.
(`)
(`)
No.
(`)
(`)
No.
(`)

100
100

Purchase
Purchase

Jan. 1
Jan. 20

Units
No.

Particulars

Date

Statement of receipts and issues by adopting First-in-First-Out Method

100
100
200
100
80
80

Value
(`)

160

100
100
200
40
200

Value
(`)

2. 60
Cost Accounting

Purchase
Purchase
Issue to Job W 16
Issue to Job W 17

Jan. 1
Jan. 20
Jan. 22
Jan. 23

100
100

Units
No.
1
2

100
200

Receipts
Rate
Value
(`)
(`)

60
60

Units
No.

1.50
1.50

Issues
Rate
(`)

90
90

Value
(`)
100
200
140
80

Units
No.
1
1.50
1.50
1.50

Balance
Rate
(`)

The Institute of Chartered Accountants of India

Material for Job W 16

Material for Job W 17
Closing Stock

FIFO
(`)
60
80
160
300

LIFO
(`)
120
100
80
300

Weighted Average
(`)
90
90
120
300

Statement of Material Values allocated to Job W 16, Job 17 and Closing Stock, under aforesaid methods

Particulars

Date

STATEMENT OF RECEIPT AND ISSUES BY ADOPTING WEIGHTED AVERAGE METHOD

100
300
210
120

Value
(`)

Material
2.61

2.62

Cost Accounting

(n) Inflated Price Method: In case material suffers loss in weight due to natural or climatic factors,
e.g., evaporation, the issue price of the material is inflated to cover up the losses.
(o) Re-use Price Method : When materials are rejected and returned to the stores or a
processed material is put to some other use, then for the purpose it is meant, then such
materials are priced at a rate quite different from the price paid for them originally. There is no
final procedure for valuing use of material.

2.9 Valuation of Returns & Shortages

2.9.1 Valuation of Materials Returned to the Vendor: Materials which do not meet

quantity, dimensional and other specifications and are considered to be unfit for production
are usually returned to the vendor. These materials can be returned to the vendor before

they are sent to the stores. In case materials reach store and are noticed to be of substandard quality, then also they can be returned to vendor. The price of the materials
to be returned to vendor should include its invoice price plus freight, receiving and
handling charges etc. Strictly speaking, the materials returned to vendor should be
returned at the stores ledger price and not at invoice price. But in practice invoice price
is only considered, the gap between the invoice price and stores ledger price is
charged as overhead. In Stores ledger the defective or sub-standard materials are
shown in the issue column at the rate shown in the ledger, and the difference between
issue price and invoice cost is debited to an inventory adjustment account.
2.9.2 Valuation of Materials Returned to Stores: When materials requisitioned for a

specific job or work-in progress are found to be in excess of the requirement or are unsuitable
for the purpose, they are returned to the stores. There are two ways of treating such returns.
(1)

Such returns are entered in the receipt column at the price at which they were originally
issued, and the materials are kept in suspense, to be issued at the same price against
the next requisition.

(2)

Include the materials in stock as if they were fresh purchases at the original issue price.

2.9.3 Valuation of Shortages during Physical Verification: Materials found short during

physical verification should be entered in the issue column and valued at the rate as per the
method adopted, i.e., FIFO or any other.

2.10 Selection of Pricing Method

No hard and fast rule or procedure has been laid down to select a method of pricing issues of
material. However, the ultimate choice of a method of selection may be based on the following
considerations.
(a)

The method of costing used and the policy of management.

(b)

The frequency of purchases and issues.

The Institute of Chartered Accountants of India

Material

(c)

The extent of price fluctuations.

(d)

The extent of work involved in recording, issuing and pricing materials.

(e)

Whether cost of materials used should reflect current or historical conditions?

2.63

2.11. Treatment of Normal and Abnormal Loss of Materials

Whichever method may be adopted for pricing materials, certain differences between the book
balance and the value of physical stock are bound to occur. These differences, which may be
a gain or loss, should be transferred to Inventory Adjustment Account pending investigation. If,
upon investigation, they are regarded as normal, they should be transferred to Overhead Control Account; if abnormal, they should be written off to the Costing Profit and Loss Account.

2.12. Accounting and control of waste, scrap, spoilage and defectives

2.12.1 Waste
Meaning

Treatment

Control

The portion of basic raw

materials lost in processing
having no recoverable value.

In Case of Normal Wastage: For effective control of waste,

Normal waste is absorbed in normal allowances for yield
and waste should be made
the cost of net output.
Waste may be visible from
past
experience,
In Case of Abnormal
remnants of basic raw Wastage: The abnormal technical factors and special
materials - or invisible; waste is transferred to the features of the material
e.g., disappearance of Costing Profit and Loss process and product.
basic
raw
materials Account.
Actual yield and waste should
through
evaporation,
be compared with anticipated
smoke etc. Shrinkage of
figures
and
appropriate
material due to natural
actions should be taken
causes may also be a form
where
necessary.
Responsibility should be
of a material wastage.
fixed on purchasing, storage,
maintenance, production and
inspection staff to maintain
standards.

A systematic procedure for

feedback of achievement
against laid down standards
should be established.

The Institute of Chartered Accountants of India

2.64

Cost Accounting

2.12.2 Scrap
Meaning

Treatment

Control

It has been defined as the

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

Scrap may be treated in cost

accounts in the following
ways:-

Control of scrap really means

the
maximum
effective
utilisation of raw material.
Scrap control does not,
therefore, start in the
production department; it
starts from the stage of
product designing. Thus the
most suitable type of
materials, the right type of
equipment and personnel
would help in getting
maximum quantity of finished
product from a given raw
material.

(i) When the scrap value

is negligible: It may be
excluded from costs. In other
words, the cost of scrap is
borne by good units and
income from scrap is treated
as other income.
(ii) When the scrap value is
not
identifiable
to
a
particular process or job:
The sales value of scrap net of
selling and distribution cost, is
deducted from overhead to
reduce the overhead rate. A
variation of this method is to
deduct the net realisable value
from material cost.
(iii) When
scrap
is
identifiable
with
a
particular job or process
and its value is significant:
The scrap account should be
charged with full cost. The
credit is given to the job or
process concerned. The
profit or loss in the scrap
account, on realisation, will
be transferred to the Costing
Profit and Loss Account.

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A standard allowance
scrap should be fixed
actual scrap should
collected, recorded
reported indicating the
centre responsible for it.

for
and
be
and
cost

A periodical scrap report

would serve the purpose
where
two
or
more
departments or cost centres
are responsible for the scrap;
the reports should be routed
through the departments
concerned.

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2.65

2.12.3 Spoilage
Meaning
It is the term used for
materials which are badly
damaged in manufacturing
operations, and they cannot
be rectified economically and
hence taken out of process to
be disposed of in some
manner
without
further
processing.

Treatment

Control

control
spoilage,
allowance
for
normal
spoilage should be fixed and
Normal spoilage (i.e., which actual spoilage should be
is inherent in the operation) compared with standard set.
costs are included in costs
either charging the loss due A systematic procedure of
to spoilage to the production reporting would help control
order or by charging it to over spoilage. A spoilage
production overhead so that report should highlight the
and
abnormal
it is spread over all products. normal
spoilage, the department
Any value realised from responsible, the causes of
spoilage is credited to spoilage and the corrective
production
order
or action taken, if any.
production overhead account,
as the case may be.

In case
spoilage

In case
spoilage

normal To

of

of

abnormal

The cost of abnormal

spoilage (i.e., arising out of
causes not inherent in
manufacturing process) is
charged to the Costing Profit
and Loss Account. When
spoiled work is the result of
rigid specification, the cost of
spoiled work is absorbed by
good production while the
cost of disposal is charged to
production overhead.

2.12.4 Defectives
Meaning

Treatment

Control

It signifies those units or The possible ways of When

defectives
are
portions of production which treatment are as below:
found, the Inspector will
can be rectified and turned (i) Defectives that
are make out the Defective
out as good units by the

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2.66

Cost Accounting

application of additional
material, labour or other
service.
Defectives arise due to substandard materials, badsupervision,
bad-planning,
poor
workmanship,
inadequate-equipment and
careless inspection. To some
extent, defectives may be
unavoidable but usually, with
proper care it should be
possible to avoid defect in
the goods produced.

Work
Report,
giving
particulars
of
the
department, process or
job, defective units, normal
and abnormal defectives,
good cost of rectification etc.

considered inherent in
the process and are
identified as normal can
be recovered by using
the following methods:
(a) Charged
to
products - The loss is
absorbed by good units. This
method is used when
seconds have a normal
value and defectives rectified
into seconds or first are
normal;

(b) Charged to general

overheads - When the
defectives caused in one
department are reflected only
on further processing, the
rework costs are charged to
general overheads;
(c) Charged
to
the
department overheads - If the
department responsible for
defectives can be identified
then the rectification costs
should be charged to that
department;
(d) Charged to Costing Profit
and Loss Account - If defectives are abnormal and are
due to causes beyond the
control of organisation, the
rework cost should be charged
to Costing Profit and Loss
Accounts.
(ii)

Where defectives are

easily identifiable with
specific jobs, the work
costs are debited to the
job.

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On receipt of the defective

Work Report, it may be
decided to rectify the
defective work; all costs of
rectification are collected
against the rectification
work order, precaution will
be taken to see that
number of defectives is
within normal limits.

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2.67

Reclamation of loss from defective units - In the case of articles that have been spoiled, it
is necessary to take steps to reclaim as much of the loss as possible. For this purpose:

(i)
(ii)
(iii)
(iv)
(v)

All defective units should be sent to a place fixed for the purpose;
These should be dismantled;
Goods and serviceable parts should be separated and taken into stock;
Parts which can be made serviceable by further work should be separated and sent to the
workshop for the purpose and taken into stock after the defects have been removed; and
Parts which cannot be made serviceable should be collected in one place for being
melted or sold.

Printed forms should be used to record quantities for all purposes aforementioned.
Difference between Waste and Scrap
Waste

Scrap

1. It is connected with raw material or inputs 1. It is connected with output

to the production process.
2. Waste of materials may be visible or
invisible.

2. Scraps are generally identifiable and has

physical substance.

3. Generally waste has no recoverable 3. Scraps are termed as by-products and has
value.
small recoverable value.
Difference between Scrap and Defectives
Scrap

1. It is loss connected with output

Defectives

1. This type of loss connected with the output

but it can be in the input as well.

2. Scraps are not intended but cannot be 2. Defectives also are not intended but can
eliminated due to nature of material or be eliminated through proper control.
process itself.
3. Generally scraps are not used or rectified.

3. Defectives can be used after rectification.

4. Scraps have insignificant recoverable 4. Defectives are sold at lower value from that
value.
of good one.
Distinction between spoilage and defectives : The difference between spoilage and
defectives is that while spoilage cannot be repaired or reconditioned, defectives can be
rectified and transferred, either back to standard production or to seconds.

The problem of accounting for defective work is the problem of accounting of the costs of
rectification or rework.

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2.68

Cost Accounting

2.12.5 Obsolescence

Meaning

Treatment

Materials
may
become
Obsolescence is defined as
obsolete under any of the
the loss in the intrinsic
following circumstances:
value of an asset due to its
(i) where it is a spare part
supersession.
or a component of a
machinery used in
manufacture and that
machinery
becomes
obsolete ;
(ii) where it is used in the
manufacture
of
a
product which has
become obsolete ;
(iii) where the material itself
is replaced by another
material due to either
improved quality or fall
in price.

Control
Losses due to obsolescence
can be minimised through
careful
forethought
and
reduced stocking of spares,
etc. Stores records should be
continuously gone through to
see whether any item is likely
to become obsolete. There
will be such likelihood if an
item has not been used for a
long time. (This does not
apply to spare parts of
machines still in use).

In all three cases, the value

of the obsolete material held
in stock is a total loss and
immediate steps should be
taken to dispose it off at the
best available price. The loss
arising out of obsolete
materials on abnormal loss
does not form part of the cost
of manufacture.

2.13 Consumption of Materials

Any product that is manufactured in a firm entails consumption of resources like material,
labour etc. The management for planning and control must know the cost of using these
resources in manufacturing. The consumption of materials takes place say when the material
is used in the manufacture of the product.
It is important to note that the amount of materials consumed in a period by a cost object need
not be equal to the amount of material available with the concern. For example, during any
period the total of raw material stock available for use in production may not be equal to the

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Material

2.69

amount of materials actually consumed and assigned to the cost object of the production. The
difference between the material available and material consumed represents the stock of
material at the end of the period.

2.13.1 Identification of Materials: For the identification of consumption of materials with

products of cost centres the followings points should be noted:
1.

It is required that the concern should follow coding system for all materials so that each
material is identified by unique code number.

2.

It is required that each product of a cost centre should be given a unique code number so
that the direct material issued for production of particular product of a cost centre can be
collected against the code number of that product.
However, it may not be possible to allocate all materials directly to individual product of a
cost centre e.g. maintenance materials, inspection and testing materials etc. The
consumption of these materials are collected for cost centre and then charged to
individual product by adopting suitable overhead absorption rate of cost centre.
Overhead absorption rate of cost centre =

Cost for cost centre

Base relating to cost centre
(e.g.labou r hrs. or machine hrs.)

3.

Each issue of materials should be recorded. One way of doing this is to use a material
requisition note. This note shows the details of materials issued for product of cost centre
and the cost centre which is to be charged with cost of materials.

4.

A material return note is required for recording the excess materials returned to the store.
This note is required to ensure that original product of cost centre is credited with the
cost of material which was not used and that the stock records are updated.

5.

A material transfer note is required for recording the transfer of materials from one
product of cost centre to other or from one cost centre to other cost centre.

6.

The cost of materials issued would be determined according to stock valuation method used.

2.13.2 Monitoring Consumption of Materials: For monitoring consumption of materials a

storekeeper should periodically analyse the various material requisitions, material return notes
and material transfer notes. Based on this analysis, a material abstract or material issue
analysis sheet is prepared, which shows at a glance the value of material consumed in
manufacturing each product. This statement is also useful for ascertaining the cost of material
issued for each product.

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2.70

Cost Accounting

Format of Material Abstract

Week Ending............
Material
requisition or
Transfer Note
or Returned
Note No.

Amount

(`)

Product Nos.

101
(`)

102
(`)

103
(`)

104
(`)

105
(`)

106
(`)

Total
for
Product

Overheads
(Indirect Material
charged)

(`)

Total

The material abstract statement serves a useful purpose. It in fact shows the amount of
material to be debited to various products & overheads. The total amount of stores debited to
various products & overheads should be the same as the total value of stores issued in any
period.

2.13.3. Basis for consumption entries in Financial Accounts: Every manufacturing

organisation assigns material costs to products for two purposes.
Firstly, for external financial accounting requirements, in order to allocate the material costs
incurred during the period between cost of goods produced and inventories; secondly to
provide useful information for managerial decision making requirements. In order to meet
external financial accounting requirements, it may not be necessary to accurately trace
material costs to individual products.
Some products costs may be overstated and others may be understated but this may not
matter for financial accounting purposes as long as total of individual materials costs
transactions are recorded i.e., transactions between cost centre within the firm are recorded in
a manner that facilitates analysis of costs for assigning them to cost units.
The consumption entries in financial accounts are made on the basis of total cost of purchases
of materials after adjustment for opening and closing stock of materials. The stock of materials
is taken at cost or net realisable value whichever is less.

2.14 Summary

Material Control: It is the systematic control over the procurement, storage and usage
of materials to maintain even flow of materials and avoiding at the same time excessive
investment in inventories.

Material Requisition Note: Document used to authorize and record the issue of
materials from store.

Purchase Requisition Note: Document is prepared by the storekeeper to initiate the

process of purchases.

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Material

2.71

Purchase Order: It is a written request to the supplier to supply certain specified

materials at specified rates and within a specified period.

Material received note: This document is prepared by receiving department which

unpacks the goods received and verify the quantities and other details.

Material Transfer Note: This document is prepared when the material is transferred
from one department to another.

Material Return Note: It is a document given with the goods being returned from
Factory back to the stores.

Bin Card: A prime entry record of the quantity of stocks, kept on in/out/balance, held in
designated storage areas.

Stores Ledger: A ledger containing a separate account for each item of material and
component stocked in store giving details of the receipts, issues and balance both in
terms of quantity and value.

Techniques of Inventory control:

Technique
Setting of various
stock levels.

ABC analysis

Description
Minimum Level: It is the minimum quantity, which must be retained in
stock
ROL- (Avg consumption X Avg. Lead time)
Maximum Level: It is the maximum limit upon which stock can be stored
at any time
ROL + ROQ (Min consumption X Min Lead Time)
Re order Level: It is the level, when reached the order needs to be
placed
Maximum lead time Maximum Usage
Or
Minimum level + (Average rate of consumption Average time to
obtain fresh supplies).
Average Inventory Level= Minimum level + 1/2 Re-order quantity
(or)
Maximum level + Minimum level
=
2
Danger Level: level where normal issue of materials is stopped, and
only emergency materials are issued.
Danger level = Average consumption Lead time for emergency
purchases
Items are classified into the following categories:
A Category: Quantity less than 10 % but value more than 70 %
B Category; Quantiy less than 20 % but value about 20 %
C Category: Quantity about 70 % but value less than 10%

The Institute of Chartered Accountants of India

2.72

Cost Accounting

Two bin system.

Establishment of
system of budgets.
Use of perpetual
inventory records
and
continuous
stock verification.
Determination
of
economic
order
quantity

Review of slow and

non-moving items.
Use of control
ratios

If one bin items exhausts, new order is placed and till the mean time
quantity from the other bin is purchased.
The exact quantity of various type of inventories and the time when they
would be required can be ascertained in advance by preparing budgets.
Continuous stock checking is done by taking different sections of the
store in rotation
It is the calculation of optimum level quantity which minimizes the total
cost of Ordering and Delivery Cost and Carrying Cost
EOQ

2AO

C
EOQ X carrying cos t per unit
Carrying Cost:
2
A X Cost per order
Ordering Cost:
EOQ
Annual Usage
No. of Orders:
EOQ
Disposing of as early as possible slow moving items, in return with
items needed for production to avoid unnecessary blockage of
resources.
Input output ratio: It is the ratio of the quantity of input of material to
production and the standard material content of the actual output.
Inventory turnover ratio:
Cost of materials consumed during the perio d
Cost of a verage stock held during t he period
Average stock=
1/2 (opening stock + closing stock)

Valuation of Material Issues

First-in First-out method: The materials received first are to be issued first when material
requisition is received. Materials left as closing stock will be at the price of latest purchases.
Last-in First-out method: The materials purchased last are to be issued first when
material requisition is received. Closing stock is valued at the oldest stock price.
Simple Average Method: Material Issue Price=

Total of unit price of each purchase

Total Nos of Purchases

Weighted Average Price Method: This method gives due weightage to quantities
purchased and the purchase price to determine the issue price.

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Material

Weighted Average Price =

2.73

Total of unit price of each purchase

Total Nos of Purchases

Various Material Losses

(a) Wastage: Portion of basic raw material lost in processing having no recoverable value
(b) Scrap: The incidental material residue coming out of certain manufacturing
operations having low recoverable value.
(c) Spoilage: Goods damaged beyond rectification to be sold without further
processing.
(d) Defectives: Goods which can be rectified and turned out as good units by the
application of additional labour or other services.

The Institute of Chartered Accountants of India