Sub enabling outcome1.2.2.

Record
materials costs.
Identify and allocate cost of materials
Record cost of materials
Apply EOQ in setting Inventory levels
Inventory in a company includes stock of raw
materials, work-in-progress, finished & semi-
finished products, spare components and by-
products,etc
Inventory control is an important feature of cost
accounting system
Introduction
•Materials cost is one of the important
elements of cost of product or unit
•For material cost control purposes, it is very
essential to know the important aspects of
material, material control and material
purchase control
•Materials needs to be properly procured, well
stored and economically used as well as proper
accounting for them
 The term “materials‟ as used in cost and
management account, covers a wide range of
items
◦ Raw Materials
◦Example, flour and sugar for biscuit, or wood for furniture
◦Work-in-Process
Usually these are partly completed goods
◦Components or “piece parts‟
◦Finished products for use or sale
Bag of cement or bottles for drinking water
◦Indirect materials
Example stationery, fuel and lubricants, and cleaning
materials
Inventoriable costs
◦ Cost that is considered to be part of the cost of
merchandise. For a retailer, the inventoriable cost is
the cost from the supplier plus all costs necessary to
get the item into inventory and ready for sale, e.g.
freight-in. For a manufacturer the product costs
include direct material, direct labor, and the
manufacturing overhead (fixed and variable).

Non-inventoriable costs
◦ These costs are treated as expenses of the
accounting period in which they are incurred because
they are expected not to benefit future periods
are 1) the costs to purchase or manufacture products which will be
resold, plus 2) the costs to get those products in place and ready
for sale. Inventoriable costs are also known as product costs.

To illustrate, let's assume that a retailer purchases an item for

resale by paying TZS20mil to the supplier. The item is purchased
FOB shipping point, which means that the retailer must pay the
freight from the supplier to its location. If that freight cost is
TZS1mil, then the retailer's inventoriable cost is TZS21mil.
Assuming this is the only item in the retailer's inventory, the
retailer's balance sheet will report inventory at a cost of TZS21mil.
When the item is sold, the retailer's inventory will decrease by
TZS21mil and the TZS21mil will be reported on the income
statement as the cost of goods sold.

In the case of a manufacturer, a product's inventoriable costs are

the costs of the direct materials, direct labor and manufacturing
overhead incurred in manufacturing the product.
Production control/inventory control/store
keeper or departmental managers initiates the
need for purchasing materials
Search for possible suppliers
◦Tenders
◦Quotation
◦Single shopping
◦Government Procurement Services Agency
◦Supplier selection
Dispatch of purchase order
Monitoring of deliveries
Receipt of goods
Procurement is the purchases of goods and
services at the best possible price to meet
purchasers’ demand in terms of quantity, quality,
dimension and size
A form known as ‘Purchase Requisition’ is
commonly used as a formal request to purchase
department to purchase the required material
Purchase department places an order with a
supplier, offering to buy certain material at
stated price and terms after receiving the
purchases requisition
The receiving department performs the function
of unloading and unpacking materials which are
received by an organization
This will need an inspection report which is
sometimes incorporated in the receiving report,
indicating the items accepted and rejected with
reasons
Bin card
A Bin card, also known as Bin Tag or Stock card, is
a card showing quantitative record of the receipts,
issues and closing balances of the material kept in
the corresponding bin
 STORES LEDGER CARD

Description Unit Location Code

Maximum Minimum Re-order level Re-order quantity

       

Date Receipts Issues Balance

  Quan Rate Amo Quan Rate Amount Quan Rate Amount

unt

                   
Material control procedures
Purchase

Receipt

Storage Stocktaking

Issue
Establishing optimal stock levels is of vital
importance of in controlling of stock
Once the optimal stock levels are established,
the store department is responsible for
ensuring that optimal stock levels are
maintained for each item of materials in stock.
Normally, a bin card is used to record the
quantity of materials in stock for each item
When items of materials have reached their re-
order point, the storekeeper will make out a
purchase requisition requesting the purchasing
department to contact with appropriate
supplier
When the purchasing department receives the
purchase requisition, the purchasing officer will
examine the different sources of supply for the
purpose of securing the highest quality
materials at the lowest price
On the receipt of the goods, the stores
department will inspect and compare the supply
with the purchase order
When the departmental foreman receives a
production order, he will give a materials
requisition to the storekeeper. On the receipt of
requisition, the storekeeper checks for
correctness and authorisation. If satisfactroy,
the issue will be made and entered the details in
bin cards. He then forwards the store
requisition to accounts department
When the accounts department receives the
stores requisition, it will price each of the items
listed on it by appropriate pricing methods (e.g
FIFO etc). Then, the amount of materials issued
is charged to appropriate job or overhead
account and the stock values are reduced
Pricing of materials may change from time to
time.
Materials are usually acquired by several
deliveries at different prices
Actual costs can then take on several different
values
Therefore, the materials pricing system adopted
should be the simplest and the most effective
one
The general principle for valuation is
that stock must be valued at cost
The question which arises here, is
what is cost? Is it replacement cost
or historical cost?
First-in-first-out(FIFO)
Last-in-first-out(LIFO)
Weight average cost (WAVCO)
Specific identification/unit cost method
This method assumes that the first stock to be
received is the first to be sold
The cost of materials used is based on the oldest
prices
The closing stock is valued at the most recent
prices
This method assumes that the last stock to be
received is the first to be sold
Therefore, the cost of materials used is based on
the most recent prices
The closing stock is valued at the oldest prices
This method assumes that the cost of materials
used and closing stock are valued at the
weighted average cost
This method assumes that each item of the
stock has its won identity
The costs of materials used and closing stock are
determined by associating the units of stock
with their specific unit cost
The stores should control its stock at an
appropriate level so as to minimize the costs
related to stock
These cost can be classified into three categories:
◦Costs of obtaining stock
◦Carrying cost
◦Stock-out-cost
Purchase costs of goods acquired
Carriage inwards
Administrative costs of purchasing and accounts
department
Loss of sale revenue due to the stop in
production
Reduction in future sales because of the loss of
goodwill
Higher costs for urgent and small order of
materials
Storage and handling cost
Interest on capital tied up by the stock
Insurance and security
Stock loss due to deterioration, obsolescence
and pilferage
Audit, stocktaking and stock recording cost
EOQ is the size of the order which contributes
towards maintaining the stocks of material at
the optimal level and at a minimum cost
 EOQ = 2*O*Q
C

Where EOQ = Economic Order Quantity

O= order cost per order
Q = Annual quantity required in units
C =Carrying cost per unit per annum
 The annual consumption of a part “X” is 5000
units. The procurement cost per order is $10 and
the cost per unit is $0.5. The storage and
carrying cost is 10% of the material unit cost.
Required:
Calculate the EOQ
O= $10 Q= $5000, C= $0.5*10%

EOQ = 2OQ
C

EOQ = 2 * 5000 *10

0.5*10%
= 1414 units
Cost $

120

Total cost
Minimum cost
80
Carrying cost

40 Ordering cost

EOQ=1414 units Unit per order

400 1200 2000
The graph shows the line representing ordering
cost sloping downward, indicating lower cost
when a large quantity is purchased and the line
representing cost of carrying stock going upward,
indicating a higher cost for a large quantity
It is to determine the correct or most optimal
stock level so as to avoid overstocking or
understocking of materials
These levels are known as the Maximum,
Minimum and Re-order levels
Re-order level formulas are given below:
1. When the business does not need to maintain
safety stock:
Maximum demand or usage (in days, weeks or
months) × Maximum lead time (in days, weeks or
months)

2. When the business needs to maintain a safety

stock:
[Maximum demand or usage (in days, weeks or
months) × Maximum lead time (in days, weeks or
months)] + Safety stock
What is lead time?
The timing difference between placing an order
with the supplier and arrival of the goods is
known as the lead time.
What is safety stock (also known as buffer stock)?
In some scenarios, it may be unlikely that the
reorder level could be estimated accurately. This
is because the demand and the lead time of the
goods could differ than the usual trends and in
that case the business may run out of stock. So,
a level of safety stock is set to avoid such a
condition. It is also known as buffer stock.
Reorder quantity is the size of each order
The formula:

Reorder quantity = Maximum stock –(Reorder level –

Minimum usage in minimum lead
time)
 The maximum stock level is highest level of
stock planned to be held
Any amount above the maximum level will be
considered as excessive stock
The formula:

Maximum level
= re-order level + Re-order quantity(EOQ) –Minimum
anticipated usage in Minimum lead
The minimum level of stock is a certain predetermined
minimum quantity of inventory which should always be
available in stock in the normal course of business.
is a kind of a precautionary level of inventory which
indicates that the delivery of raw materials or merchandise
may take more than the normal lead time.
If the level of stock strikes the minimum level, the
management of the company must make sure that they
corroborate with the supplier and take other necessary
measures to make the goods (inventory or raw materials)
available in time so that the business operations are not
disturbed or delayed.

Minimum level=
Re-order level – Average usage x average lead time
Units

Maximum level
1500

Reorder level
1000

Minimum level
500

Weeks
Average usage 100 units per week
Minimum usage 70 units per week
Maximum usage 140 units per week
Lead time (the time between ordering 3-5 weeks
and replenishment of goods)
Ordering cost per order $180
Annual cost of carrying a unit in stock $5.20
Safety stock 40 units per week
Calculate:
a) Economic Order Quantity (EOQ)
b) Reorder level with and without safety stock
c) Reorder quantity
d) Minimum level
e) Maximum level
EOQ = 2OQ
C

EOQ = 2 * $180 *5200

5.2
= 600 units
 (a)Re-order level without safety stock
= (Maximum consumption * Maximum re-order period )
= 140 units *5
= 700 units
(b) Re-order level with safety stock
= (Maximum consumption * Maximum re-order period )
+ safety stock
= (140 units *5)+ 40 units
= 740 units
Note: If the question has provided safety stock use
formula (b) no safety stock use formula (a)
Minimum level

= Re-order level – Average usage x average lead time

= 740 units – (100 units *4)
= 340 units
Maximum level

= re-order level + EOQ –Minimum anticipated usage

in Minimum lead

= 740 units +600 units – (70 units *3)

= 1130 units
 Reorder quantity

= Maximum stock –(Reorder level –

Minimum usage in minimum lead
time)
= 1130 units – (740 units – 70 units *3)
= 600 units
Calculate assuming there is no safety stock
a) Reorder quantity
b) Minimum level
c) Maximum level