Professional Documents
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From PC Direct
From PC Direct
From PC Direct
Definition; The term material refers to all commodities consumed in the process of production.
The material is an important part of cost of a product. Without material or stock no
manufacturing and other operations may take place. Materials are needed in all forms of
operating environments.
Material classifications
Materials take three forms i.e. raw materials, work in progress and finished goods.
Materials can also be direct or indirect.
Direct materials form an integral part of finished products and can be
economically and conveniently identified with the final product and its vise –
versa for the indirect materials.
Materials control basically aims at efficient purchasing of materials, their efficient
storage &efficient usage or consumption.
Material control consists of two control levels:
(i) Quantity controls, i.e. lesser and lesser units should be used in the production process.
(ii) Finance controls, i. e. ensuring that investment in materials is kept at the lowest level
possible.
A materials purchases procedure is necessary to ensure that goods are purchased at the right
time, of the right quality and in right quantity. This is because over –purchase can lead to
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loss/wastage obsolescence etc. whereas under –purchasing can result into production stoppages
hence affecting sales. The purchasing policy of an entity should be in position to meet the
following objectives;
i. Budgetary control (materials should have been budgeted for a specified production
period).
ii. Purchase initiation through a purchase requisition form to the purchase department –
which has to verify the need.
iii. Tendering process (involves use letter of inquiry, quotations, advert to invite tenders.
This must be transparent).
iv. The purchase order (a form is given to the successful bidders)
v. Receipt of materials with a delivering note from the supplier.
Involves reconciliation of the delivery note with the purchase order.
Physical counting & inspection
Technical inspection (it should involve officers of the user departments)
Raise an inspection note.
If it‟s good quality& quantity, GRN is received & signed
vi. Supplier raises an invoice demanding payment; it contains details of units, unit price,
discounts allowed, transport charges, etc.
It‟s sent to the accounting officer for approval
It‟s then sent to the accounts department to process payment.
Reconcile the purchase order & GRN
Documents stamped, paid & serially numbered.
vii. Payment affirmed by issue of a receipt by the supplier.
Store keeping
These include;
Centralised stores
Decentralized stores
Imprest stores
Centralized storage
Disadvantages
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Decentralized storage
Here materials are held and issued by sub stores in each department/ branch.
NB; advantages and disadvantages are a vise-versa of the above (the centralized storage)
Imprest storage
Under this system, materials are received by the central stores but some items of these are issued
to some sub stores on the basis of imprest system. This system is similar to petty cash system
whereby a specific/preset quantity of each item of material is issued to the store keeper of a
specific department at the start of a given period. At the end of such a period, the store keeper
will inform about the number of such items of materials used for production and other
operations. Then such a specific number used will be replaced at the start of the next period.
Materials requisition note; this is an authorization to the store keeper issue raw materials.
It‟s normally signed by authorized personnel of the user department.
Stock record /ledger card/bin card; this records materials received and issued. Has 3
columns i.e. stock purchases (receipts), stock issues and stock balance.
A ledger card /stores ledger shows both quantities and monetary values of stock
items where as
A bin card shows only the number of various items in stores at a particular date in
terms of issues and receipts while the balance column only shows unit balances.
Material return note; the document permits unused materials to be returned in the store.it
contains details of materials returned, reasons for return, the job to which it originally
related and must be signed.
Material transfer note; Permits the transfer of materials from one location to another, job
to another in case one job is in excess of another but another job in need of such
materials. It contains details of transferred materials, job numbers involved,
Scrap Note; Records scraps generated during operations and production. It further allows
exchange of a scrap for good materials from the store to the user department.
Shortage note; Issued by the store keeper to the user section specifying that materials
needed are not enough or available
Bill of materials; Master requisition given to the storekeeper listing all materials required
for a particular job.
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MATERIALS CODING;
This is a system of symbols designed to be applied to a classified set of items to give a brief
accurate reference facilitating entry, collation and analysis.
Rationale of coding
Principles of coding:
Exclusive; it means each item should have only one code and this code should not be
used for any other item.
Certainty; codes used on different materials should be certain and there should be no
possibility of confusion.
Elasticity; it means the code numbers should be arranged in such a way that it must be
possible to include new items if need arises.
Brevity; codes should be as brief as possible
Memorization; it should be easy and possible to remember and understand the code
numbers
Uniformity; codes should be of equal length and of the same structure.
STOCK-TAKING
It‟s the physical checking of stock items in order to ensure that stock quantities shown on stock
records and actual quantities are the same.
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Periodic stock taking; Here all stocks are counted at one time at regular intervals such as
quarterly, six months or yearly. The physical quantities of stock are ascertained at the end
of every period. Here stock taking may take hours or a couple of days. It may involve
closing normal business operations to carry it out.
This method may pose a difficulty of discovering discrepancies.
Stock control involves ensuring that the business has the right quantity of goods, in the right
place and at the right time. Stock should not be allowed to be neither too high nor too low.
Optimum levels should be maintained at any one point in time.
Holding and carrying costs (salaries & wages, light and heat insurance)
Ordering costs (transportation/carriage, postage ,inspection and insurance
Purchase cost
NB: Ordering and handling/holding costs are minimum to stop overstocking and under stocking
of materials.
Over stocking costs; these include opportunity costs, security costs, storage, pilferage,
obsolescence etc.
Under stocking costs; these include customer loss, redundancy costs, stoppages, lost
sales revenue etc.
Availability; if a particular material is easily available throughout the year and when
needed, the stock level should be low and vice versa.
Lead time; this is the time lag between when an order is made and when goods are
actually received. If the lead time is long, the stock levels should be quite high and vice-
versa.
Handling /holding costs; this is the cost of keeping materials into stores. If such HC/CCs
are high, then stock level should be low and vice-versa.
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Consumption; if a given material is consumed /used /needed in greater quantities, then
levels should be high and vice-versa
Trade discount; if the supplier offers higher discount for larger purchases and the benefit
of trade discount is over and above handling costs, the stock can be maintained at higher
levels.
Durability; the stock level of durable goods can be maintained at higher level but in case
of perishable goods , low levels of such should be maintained;
This analytical approach is called the ABC analysis and tends to measure the significance of
each item of inventories in terms of its value.
The high-value items are classified as 'A items' and would be under the tightest control.
'C items' represent relatively least value and would be under simple control.
'B items' fall in between these two categories and require reasonable attention of management.
The ABC analysis concentrates on important items and is also known as control by
importance and exception (CIE).
As the items are classified in the importance of their relative value, this approach is also
known as proportional value analysis. (PVA).
The following steps are involved in implementing the ABC analysis:
1. Classify the items of inventories, determining the expected use in units and the price per unit
for each item.
2. Determine the total value of each item by multiplying the expected units by its units price
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3. Rank the items in accordance with the total value, giving first rank to the item with highest
total value and so on.
4. Compute the ratios (percentage) of number of units of each item to total units of all items and
the ratio of total value of each item to total value of all items.
5. Combine items on the basis of their relative value to form three categories: A, B and C.
J.I.T PURCHASING
Under this system materials arrive exactly at the time they are needed for production. The just-
in-time (JIT) system is used to minimize inventory investment. Ideally, the firm would have only
work-in-process inventory. Because its objective is to minimize inventory investment, a JIT
system uses no, or very little, safety stocks. Extensive coordination must exist between the firm,
its suppliers, and shipping companies to ensure that material inputs arrive on time. Failure of
materials to arrive on time results in a shutdown of the production line until the materials arrive.
Likewise, a JIT system requires high-quality parts from suppliers. When quality problems arise,
production must be stopped until the problems are resolved. The goal of the JIT system is
manufacturing efficiency. It uses inventory as a tool for attaining efficiency by emphasizing
quality in terms of both the materials used and their timely delivery. When JIT is working
properly, it forces process inefficiencies to surface and be resolved. A JIT system requires
cooperation among all parties involved in the process-suppliers, shipping companies, and the
firm's employees.
This represents a level at which it becomes necessary to initiate purchase of new /fresh supplies.
This level is normally higher than the minimum stock level but lower than the maximum stock
level.
That is the stock level that should be held by an organization at any point of time even if stock
slightly falls below the minimum stock level.
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NB: In some instances min‟ stock level acts as safety stock level depending on the organization‟s
policy.
This is a level generally determined below the minimum and safety stock levels & represents the
level where immediate steps are taken for getting stock replenished. In some cases, danger level
of stock is fixed above the minimum level, but below the re-order level.
Example One; You are availed with the following information for a given stock RM255;
Delivery days 3 2 4 6
RE-Order 80,000 60,000 60,000 60,000
qty(bags)
Usage per day 4000 4,200 4,400 4,300
(bags).
v. In addition, holding costs per kg is ugx, 1,000 and ordering costs per kg, ugx. 5,000.
Example three; Kwekamba Enterprise produces and sells wheat flour in Nakawa. During the
first week of November 2021, the stores assistant provided you with the following information
from its stores;
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Minimum usage is 250kgs per week and maximum usage is 750kgs per week
Minimum lead time is 4 weeks and maximum lead time is 6 weeks
Re-order quantity 3,000kgs
Required. Compute;
i. Re-order level
ii. Minimum stock level
iii. Maximum stock level
iv. Average stock level
It is the optimum (most favorable) quantity that should be purchased in case a purchase is to be
made i.e.one which minimizes ordering and carrying costs. It is obtained at that level where
carrying /holding costs = ordering costs.
NB: As the order size increases, ordering costs per unit reduce but HC (CC) per unit increases
as the order size increases.
Graphical illustration;
The two curves meet where total costs are minimum (carrying costs and ordering costs)
Algebraically;
EOQ = 2 X Dt x Oc.
Cc
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Where Dt – demand per time e.g. yearly, monthly etc
Ordering Costs
The term ordering costs is used in case of raw materials (or supplies) and includes the entire
costs of acquiring raw materials. They include costs incurred in the following activities:
requisitioning, purchase ordering, transporting, receiving, inspecting and storing (store
placement). Ordering costs increase in proportion to the number of orders placed.
Carrying/ holding /handling costs
Costs incurred for maintaining a given level of inventory. They include storage, insurance, taxes,
deterioration and obsolescence. The storage costs comprise cost of storage space (warehousing
cost), stores handling costs and clerical and staff service costs (administrative costs) incurred in
recording and providing special facilities such as fencing, lines, racks etc.
Assumptions of EOQ
Constant or uniform demand: Although the EOQ model assumes constant demand,
demand may vary from day-to-day. If demand is stochastic that is, not known in advance –
the model must be modified through the inclusion of a safety stock.
Constant unit price: The EOQ formula derived is based on the assumption that the purchase
price of material will remain unaltered irrespective of the order size. Quite often, bulk
purchase discounts or quantity discounts are offered by suppliers to induce customers for
buying in larger quantities.
Constant carrying costs: Unit carrying costs may vary substantially as the size of the
inventory rises, perhaps decreasing because of economies of scale or storage efficiency or
increasing as storage space runs out and new warehouses have to be rented. This situation can
be handled through a modification in the original model similar to the one used for variable
unit price.
Constant ordering costs: While this assumption is generally valid, its violation can be
accommodated by modifying the original EOQ model in a manner similar to the one used for
variable unit price.
Instantaneous delivery/replenishment: If delivery is not instantaneous, which is generally
the case, the original EOQ model must be modified by including of a safety stock.
Independent orders: If multiple orders result in cost savings by reducing paperwork and
transportation cost, the original EOQ model must be further modified. While this
modification is somehow complicated, special EOQ models have been developed to deal
with this.
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Example three; A company‟s annual demand for material RQ201 is 25000 tonnes per annum.
The cost price per ton is shs 20,000 whereas the stock holding is expected to be 25% per annum
of the stock value. The delivery cost per batch is shs 4,000
Example four; A certain firm has obtained operational items of equipment from an outside
supplier at ugx 3000 per item. Total annual needs are 8000 items. You have with you the
following further data concerning this firm;
The annual demand for an item of stock is 45 units. The item costs $200 per unit to purchase, the
holding costs for one unit for one year is 15%of the unit cost and ordering costs are $300 per
order.
Required: calculate
i) The EOQ
ii) Number of orders to be made in a year
iii) The total material management costs
Trial question
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PRICING OF MATERIAL ISSUES AND CLOSING STOCK VALUATION
Here there is a difficulty of attaching a cost to the issues done at different intervals.
This is so because the same type could have been purchased at different prices during different
periods.
The Methods
Historical cost –based methods (usually accepted for external fin‟ reporting)
Decision –making and internal reporting methods.
FIFO;
This requires that the oldest items in the stores are issued out first.
Such that closing stock is composed of current items.
Cost of sales is therefore understated while sales are overstated which overstates profits.
NB; The method may not reflect a fair-value (current market value) of goods especially in case
of price fluctuations.
LIFO;
NB; The closing stock does not reflect the current prices and hence may be irrelevant to
match with current conditions.
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Advantages and disadvantages
WACO/AVCO;
This method tries to minimize extremes of LIFO and FIFO in relation to materials
valuation.
Since FIFO overstates closing stock and net profit, while LIFO understates them.
Here the weighted average issue cost/price is computed each time a transaction is made.
WACO AVCO= purchase cost of previous units + purchase cost of current units.
Previous units + current units
Standard cost Method: Materials are priced based on a standard cost which is
predetermined. When the material is purchased the stock account will be debited with the
standard price. The difference between the purchase price and the standard price will be
carried into a variance account.
Example Five
The following information is extracted from the stores ledger of Meena Ltd for the month of
July, 2011
Opening Stock 55 units @ Ugx 1,500 per unit.
Purchases:
July 1 175 units @ ugx 1,700 per unit
July 5 80 units @ ugx 1,400 per unit
Issues:
July 16 105 units
Purchases:
July 12 105 units @ ugx 1,500 per unit
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July 21 84 units
July 30 45 units
Required;
i. Carry out the purchases and issues valuation by adopting the FIFO and WACO method.
Example six
The following information is availed to you concerning materials records of a certain
manufacturing firm for the month of June, 2016.
June 1st opening balances 100 units at 1000 each
3rd purchases 50 units at 1,200 each
5th purchases 30 units at 1,300 each
8th shortages 09 units
10th issues 40 units
15th issues 70 units
20th purchased 30 units at 1,500 each
22nd purchased 10 units at 1,600 each
24th returns 15 units
27th issued 25 units
30th issued 70 units
NB; the 8 units shortage was part of 3rd purchases while the returns on 24th had been from issues
made on 15th to a user department.
Required;
Prepare a stores ledger card and determine the following;
i. Cost of goods used in production
ii. Value of closing stock using the following methods.
a. FIFO
b. LIFO
c. AVCO
Example seven;
a) An organization should follow a good purchase procedure to avoid consequences like “air
supply” and over-invoicing among others. Describe the procedure clearly bringing out the
key issues that should be observed at each stage.
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b) Recco industries ltd is manufacturing company of and has availed you the following
information concerning its materials records for the month of October, 2010.
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