2 - COSTING FOR MATERIALS

Material Control is a management function that is concerned

with the storage, handling, and use of materials to minimize waste
and improve inventory accuracy. This process can be beneficial for
companies to reduce costs and improve organization and productivity.

The main object of material control is to ensure smooth and

unrestricted production. Production stoppages and production delays
cause substantial loss to a concern.

Principles of material control

The principles of material control include proper coordination
among various departments, centralized purchasing, standard forms for
requisitions and orders, classification and codification of materials,
efficient stores arrangement, internal checks, and regular reports on
materials.

Purchasing procedures
Different steps of purchasing:

● Determine Your Business Needs.

The procurement cycle begins at the point when you realize
your organization needs to procure goods or services from an
external supplier. At this stage, it’s important to understand your
budget constraints, the overall objectives of your business, and the
priorities of individual departments.
● Complete a market analysis.
Next up, you’ll need to complete a thorough market analysis.
This ensures your team has a robust understanding of the options
available to you – ultimately enabling you to compile a list of
prospective suppliers. Your market analysis ought to consider costs,
key players, and challenges and dynamics, alongside how the market
is evolving.
Once you have completed your market research, produce a
market summary document that details your key findings.

● Compile a list of suitable suppliers.

With your market summary in hand, you will be equipped with
all the information you need to put together a list of suitable
suppliers.
Make sure you are shortlisting vendors with your top priorities
in mind. Priorities may include driving innovation throughout the
supply chain, sourcing locally, efficiency, cost reduction, or fostering
a close working relationship with your supplier.

● Produce Tender Documents.

You’ll need to provide your shortlisted suppliers with detailed
specifications, outlining your budget, volume requirements, time
scales, service level agreement, and terms and conditions.
 ● Issue RFI, RFQ, or RFP.
When a buying organization disseminates a Request for
Information (RFI), they are seeking general information about
prospective suppliers' capabilities and services/goods. The next
phase in the procurement process involves either a Request for
Quotation (RFQ), or a Request for Proposal (RFP).

Depending on the complexity of your procurement process, you may wish to launch the RFx process
to your shortlisted suppliers. This could include a request for information (RFI), request for quote (RFQ), or
request for proposal (RFP).

In more complex scenarios, an RFP can provide you with more detailed information around several
factors. On the other hand, if you know exactly what you want and when you need it, an RFQ might be more
than sufficient.

This process can be a little lengthy and time-consuming, but don’t be tempted to cut corners.
It’s important to find a supplier that can best serve your business needs.

● Negotiate and award the contract to your preferred supplier. .

Negotiate to reach agreement on the terms and deliverables of the
contract. Aim for a fair and sustainable agreement that improves both
parties' relationship.
● Finalize the purchase order.
Buyers need to finalize every PO they generate. Typically this
occurs when an invoice marked “final payment” is processed in
Accounts Payable.
 ● Process Payment.
Payment processing is how businesses complete payment
of money from a customer's issuing bank that can be transferred
to a merchant's account.

Elements of store keeping

● To ensure uninterrupted supply of materials without delay

to various users of the organization.
● To prevent overstocking and understocking of the materials.
● To ensure safe handling of materials and prevent their
damage.
● To protect materials from pilferage, theft, fire and other
risks.
Store keeping is the task of maintaining safe custody of all items
of supplies, raw materials, finished parts, purchased parts, and other
items. These items are held in a storeroom for which a storekeeper
acts as a trustee.

Objectives and principles of stock recording

Store Management
Store management is concerned with ensuring that all the activities
involved in storekeeping and stock control are carried out efficiently and
economically by the store personnel.

The basic responsibilities of a store are to act as custodian and

controlling agent for the materials to be stored, and to provide service
to users of these materials. Proper management of store systems
provide flexibility to absorb the shock variation in demand and enable
purchasing to plan ahead.

Since the materials have a cost, the organization is to manage the

materials in store in such a way so that the total cost of maintaining
materials remains optimum and an efficient store management can
help with this.

An efficient store management can ensure that right

materials reach the right person at the right time hence
avoiding any kind of production delays. It also ensures that
materials are stored properly hence least wastage of materials
occurs.
Two approaches of stock taking

1. Annual stocktaking: – occurs once a year and all of the

stock is recorded at once. This is the minimum frequency
that businesses should consider to keep their records
accurate.
2. Periodic stocktaking: – occurs every month, few months or
twice a year.

Features of pricing system

A price is simply the assignment of a numeric value to a product.
Prices help us to make everyday economic decisions about our needs or
desires. Prices are an indication of the popularity of a product. Therefore,
the more popular the product, the higher the price that can be charged.
The four characteristics of the price system are that it is neutral, market
driven, flexible, and efficient. It is neutral because prices do not favor the
producer or the consumer because they both make choices that determine the
equilibrium price.

Prices are neutral because neither producers or consumers can impact prices; this means
that consumers can buy whatever they want and producers can make and sell whatever they want.
Producers offer goods and consumers either say ''yes'' or ''no'' with dollars. Thus, prices are decided
by many interactions between producers and consumers. The market price is the point that the
supply and demand curves intersect.
 A surplus means that quantity is greater than demand. When quantity is greater than
demand, it causes prices to go down. Otherwise, in a shortage situation (where quantity is less than
demand) it causes prices to go up due to scarcity. An example of a shortage situation is housing in
New York City.

As previously discussed, producers can make what they want and consumers are free to purchase
what they want. This means we live in a market economy. Example smart phone -

The characteristics of the main issue pricing systems; First-in first-out

(FIFO), Last in First Out(LIFO), Average Pricing and Standard pricing

FIFO (“First-In First-Out”) assumes that the oldest products in a company's

inventory have been sold first and goes by those production costs.
The LIFO (“Last-In, First-Out”) method assumes that the most recent products in
a company's inventory have been sold first and uses those costs instead.

Characteristic of FIFO method

First In, First Out (FIFO) is an accounting method in which assets

purchased or acquired first are disposed of first. FIFO assumes that the remaining
inventory consists of items purchased last. An alternative to FIFO, LIFO is an
accounting method in which assets purchased or acquired last are disposed of first.

FIFO method of pricing issues:

FIFO stands for “First-In, First-Out”. It is a method used for cost flow assumption
purposes in the cost of goods sold calculation. The FIFO method assumes that the
oldest products in a company's inventory have been sold first. The costs paid for those
oldest products are the ones used in the calculation.
Characteristics of LIFO

Last in, first out (LIFO) is a method used to account for inventory. Under
LIFO, the costs of the most recent products purchased (or produced) are the first
to be expensed.

LIFO method of pricing issues:

The issues are priced out at the most recent batch received and
continue to be charged until a new batch is arrived into stock. It is a method
of pricing the issue of material using the purchase price of the latest unit in
the stock.

The FIFO method of inventory accounting has two other advantages:

As inventory is consumed in the same order as it is purchased, it’s

easy to follow this method.
 The value of the company’s inventory in its books at the end of the
year reflects a more accurate picture. As it has been acquired
recently, the amount is closer to the market value. Under the LIFO
method, inventory valuation is out-of-date.

This method is useful for materials which are subject to obsolescence and
deterioration In periods of rising prices, the FIFO method produces higher profits
and results in higher tax liability because lower cost is charged to production.

FIFO helps food establishments cycle through their stock, keeping food
fresher. When employees monitor the time food spends in storage, they improve
the safety and freshness of food. FIFO can help restaurants track how quickly
their food stock is used.

FIFO and LIFO--An example

Say a company purchases 100 units of inventory at $10 each.

Subsequently, it buys another 100 units at $15 per item. If it uses the
LIFO method of inventory valuation, it will consume the $15 items first.
Consequently, its cost of goods sold (COGS) would be higher than if it
had consumed the $10 items. Remember that the FIFO method would
have required the $10 items to be consumed first.

Let’s see the financial impact of consuming 100 units under the two
methods:

COGS with the LIFO method: 100 units X $15 = $1,500

COGS with the FIFO method: 100 units X $10 = $1,000

2. Calculate the closing inventory by using FIFO method

receipts issue

1 Jan 10 @ 12
3 Jan 7

10 Jan 13 @15

15 Jan 14

20 jan 12 @8

30 jan 5

Calculations:

receipts issue Balance

$

1 Jan 10 @ 12 120

3 Jan 7 3 @$12 = 36

10 Jan 13 @15 231

15 Jan 14 2@15 =30

20 jan 12 @8 126

30 jan 5 9@8=72
Example:

LIFO method, i.e. last in first out method, is one of the methods used to
value the inventory of the business where the assumption of the this
method is that the goods that are purchased/produced at last are sold
firstly by the business organization, and the items that are
purchased/produced at first are assumed to remain idle in the store.

Suppose Mr. Arun started a Retail business of stationery on February 1st,

2022. He purchases identical registers from a wholesaler. The purchases
for the month of February and March 2022 are as follows:
 Date Units Price($) Total($)

01-Feb 500 20 10,000

15-Feb 200 20.5 4,100

25-Feb 300 21 6,300

05-Mar 100 21.5 2,150

20-Mar 50 22 1,100

TOTAL 1150 23,650

At the end of March, Mr. Arun finds out that the total registers sold by
him are 500 units @30 each. So now we need to calculate the value of
the cost of goods sold and closing inventory as of March 31st, 2022.

Solution:

As the LIFO method of valuation is followed so inventory that is

purchased at last will be considered to be sold first, so the registers
purchased on March 20th should be included in cost first, then the
registers purchased on March 5th and so on. Since the total units sold
were 500 only, 50 units of inventory purchased on Feb 15th are to be
taken in the cost of goods sold calculation. The remaining 150 units are
considered in the closing inventory, along with the oldest inventory that
was purchased on February 1st.
Following is the Tabular representation of the Calculation of Cost of
goods sold and Closing inventory as of March 31st. 2022.

Value of Cost of goods sold:

Date Units Price Total

20-Mar 50 22 1,100

05-Mar 100 21.5 2,150

25-Feb 300 21 6,300

15-Feb 50 20.5 1,025

Total 500 10,575

Value of Closing inventory:

Date Units Price Total

15-Feb 150 20.5 3,075

01-Feb 500 20 10,000

Total 650 13,075

Therefore, the value of the cost of goods sold is $10,575, and value of
closing inventory is $13,075, and the profit is $4,425 (500*30-$10,575).
The difference between LIFO and FIFO are as follows:

1. FIFO method, i.e. the first in first out method of inventory valuation,
is based on the assumption that the items inventory that is
purchased first are sold first, whereas, in the case of the LIFO
method, the assumption is that the items of inventory that are
mostly produced most recently are sold first by the business
organization.
2. Under the FIFO method, the value of closing inventory is more, and
the cost of goods sold is less as compared to the value of closing
inventory and cost of goods sold valued as per the LIFO method
because, under the FIFO method, the value of inventory includes
the cost of items that are recently produced and cost of goods
includes the cost incurred in production or purchase of old items
and obviously at this time of inflation, costs of recently produced
items are more than the costs of items that are produced earlier.
3. The FIFO method is considered more realistic and logical than the
LIFO method as the FIFO method doesn’t let the old inventory
remain idle in the store.

Advantages of the LIFO method

The advantages of LIFO method are as follows:

1. LIFO method is easy to implement and understand.

2. It provides tax benefits to the business organizations by reporting
less profits and deferring Income Tax payment in the future years.
 3. LIFO method provides the benefit of matching the current cost with
the current revenues thereby reducing the profits included in the
inventory.

Disadvantages of the LIFO method

The disadvantages of LIFO method are as follows:

1. At the time of inflation the LIFO method results in hiding the actual
profits of the business which can result in the negative impact
about the business profitability position in the minds of the
investor.
2. The inventory figure is also understated at the time of inflation
because the inventory includes the cost of products that are
manufactured or purchased earlier and the cost of old products is
less than the new ones.
3. LIFO method is more complex when the prices of the products
keep.

3. ABC Started a Retail business of stationery on February 1st, 2022. He

purchases identical registers from a wholesaler. The purchases for the
month of February and March 2022 are as follows:
 Date Units Price($) Total($)

01-Feb 600 30 18000

15-Feb 300 20 6000

25-Feb 300 15 4500

05-Mar 100 21 2,100

20-Mar 60 25 1,500

TOTAL 1360 32100

At the end of March, ABC finds out that the total registers sold by him are
500 units @30 each. So now we need to calculate the value of the cost
of goods sold and closing inventory as of March 31st, 2022.

Average Pricing and Standard pricing

Average Price (Moving Average Price)

Moving average price is an inventory costing method where the

average price is calculated after obtaining the goods. The
average cost of each inventory item in stock is re-calculated
after every inventory purchase.

To calculate it, you would use this formula:

Moving Average Price = (Products On Hand Value + New Products
Value) / Total Number of Products

The moving average price is a constantly recurring calculation, which

could potentially change with each invoice or goods receipt.

Standard Price

Standard price is a predetermined price, and both receipts and

issues will be valued at this price. It also remains constant for a certain
amount of time, such as a quarter, a month, or some other time frame.
This method follows the standard costing technique of accounting, or
the practice of substituting an expected cost for an actual cost in the
accounting records. Subsequently, variances are recorded to show the
difference between the expected and actual costs. Compared to
collecting actual costs, standard costs could be used as a close
approximation to actual costs and would have significant accounting
efficiencies.

In the common practice, raw materials use the moving average price
and semi-finished/finished products use the standard price.

If either the moving average price or standard price method is selected in

the material master record, the system just follows the accounting rules
to do the inventory cost postings.

Example
Let’s take a look at an example of how the SAP system proceeds using the
moving average price.

When the “V” value is selected in the price control field of the material master
record, the system will use the moving average price method for this material.
In the figure above, purchasing prices are different in each acquisition. The
system would post an inventory balance based on each purchasing price, and
update the latest moving average price in the material master record. Total
stock and total value are also updated accordingly. Since goods issues are
usually valued with the current moving average cost, they do not normally
affect the inventory cost.

Compare this to the standard price example below.

**Booked inventory value = Standard Price * Units count
**Price difference = (Purchasing price – Standard price) * Units count

When the “S” value is selected in the price control field of the material master
record, the SAP system will use the standard price method for this material.
As shown in the standard price table above, even when purchasing prices are
different, the system always uses the fixed standard price to post inventory
balance in the given period. The differences between purchasing price and
standard price are posted to a price difference account. Total stock and total
value are also updated by standard price in material master record. In this
case, goods issues are usually valued with the standard price.

Question 1:
Calculate the moving average price
 Period Item Units Purchasing Booked Moving
price ($) Inventory average
value ($) price ($)

Balance b/d Material X 20 10

Jan 12 Material X 300 12

purchase

Jan 18 Material X 25 15
purchase

Closing
balance

Period Item Units Purchasin Booked Standard Price

g price ($) Inventory price ($) difference
value ($) ($)

Balance Material X 20 10 10
b/d

Jan 12 Material X 300 12 10

purchase

Jan 18 Material X 25 15 10
purchase

Closing
balance

Question 1:
Calculate the moving average price
Period Item Units Purchasing Booked Moving
price ($) Inventory average
value ($) price ($)
Balance b/d Material X 20 10 200 10

Jan 12 Material X 300 12 3600 11.87

purchase

Jan 18 Material X 25 15 375 4175/345=

purchase 12.10

Closing 345 4175

balance

Period Item Units Purchasin Booked Standard Price

g price ($) Inventory price ($) difference
value ($) ($)

Balance Material X 20 10 200 10 0

b/d

Jan 12 Material X 300 12 10X300= 10 600

purchase 3000

Jan 18 Material X 25 15 10X25 10 125

purchase =250

Closing 345 3450 10 725

balance