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Material Costing - Theory & Practical Questions-3
Material Costing - Theory & Practical Questions-3
(iv) Maximum level: This is the level above which stocks should not normally be allowed
to rise. The maximum level may, however, be exceeded in certain cases. E.g. when
unusually favourable purchasing conditions arise. Maximum level is calculated by the
following formula:
Maximum Level = Re-order level (ROL) + Reorder quantity (ROQ) –
{Min. Consumption x Min. Reorder period}
The idea of setting maximum stock level is to ensure that capital is not unnecessarily
blocked in stores and also to avoid loss due to obsolescence and deterioration.
(v) Minimum level: It is that level below which stock should not normally be allowed to
fall. This is essentially a safety stock and is not normally touched.
Minimum level = Re-order level – {Normal consumption x normal re-order period}
Note: Normal consumption means Average consumption.
Average consumption = (Maximum consumption + Minimum consumption) ÷ 2
3) Economic order quantity (EOQ):
Example for understanding Economic order quantity
Annual Consumption = 2,400 units.
Ordering Cost per order = Rs. 10.
Holding Cost = Re. 0.30 per unit
(A) (B) (C) (D) (E) (F)
Number of units per Average
Ordering Holding Cost Total
No. of order Inventory
cost = (C) x Re. Cost
Orders (Annual consumption ÷ (In units)
= (A) x Rs. 10 0.30 (D) + ( E)
No. of orders) = (B) ÷ 2
1 2,400 1,200 10 360 370
2 1,200 600 20 180 200
3 800 400 30 120 150
4 600 300 40 90 130
5 480 240 50 72 122
6 400 200 60 60 120
7 343 172 70 52 122
8 300 150 80 45 125
Re-order quantity is the quantity for which order is placed when stock reaches re-order
level. By fixing this quantity the purchaser doesn’t have to recalculate the quantity to be
purchased each time when he places order for materials.
Ordering cost is the cost incurred for placing one order.
Carrying costs are the cost for holding / carrying of inventories in the store such as the
cost of fund invested in inventories, cost of storage, insurance cost, obsolescence etc.
Economic Order Quantity is also known as Re-order quantity because it is the quantity
which is most economical to order. In other words, EOQ is the level at which the total
cost (ordering cost + carrying cost) is minimum.
SVKM’s NMIMS, Navi Mumbai Campus 3|Page
F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2023-24]
(iv) Receipt of Materials: All incoming materials should be received by the Receiving
Department. This department performs the functions of unpacking and verifying the
quantities and conditions of goods. The quantity received is duly verified with the
purchase order and supplier’s advice note. Usually four copies of receipt of materials
is prepared to be sent to purchase dept, storekeeper, accounting department and one
copy is retained with the receiving department.
(v) Inspection and Testing of Materials: Goods received should be inspected for quality
to ensure that they comply with specifications stated on the purchase order. If lab
testing is a pre requisite then the same should have a report of the same. An
inspection report is prepared to show the results of the inspection and is forwarded
to the purchasing department.
(vi) Return of Rejected Materials: Where materials received are damaged o tar not in
accordance with the specifications, these are usually returned to the supplier along
with a Debit Note. When such a claim is accepted by the supplier, he signifies his
acceptance by the issue of a Credit Note.
(vii) Passing Invoices for Payment: When the invoices are received by the purchasing
department, the process of assembling the business papers connected with each
purchase and preparation of voucher begins. Invoices are numbered serially and
entered in the Invoice Register. The following documents are assembled in support of
the invoice:
a) Purchase order.
b) Goods received note.
c) Inspection Report.
d) Debit or Credit Note.
Important Note: Real Material Cost will be arrived at after adjusting the following
items in the purchase price: (a) Quantity discount, (b) Trade discount, (c) Cash
discount, (d) Sales tax and other levies, (e) transport charges, (f) cost of containers.
5) Proper storage of materials: Storekeeping is the function of receiving materials, storing
them and issuing these to departments. The stores department is under the control of a
person known as storekeeper or store superintendent.
Objectives of good Storekeeping:
a) Protection of materials from losses due to fire, evaporation, obsolescence.
b) Avoiding over stocking and under stocking.
c) Economical use of storage space.
d) Upto date stores records.
e) Immediate location of materials required.
f) Facilitating perpetual inventory.
g) Speedy receipts and issues of stores.
h) Minimize storage cost.
SVKM’s NMIMS, Navi Mumbai Campus 5|Page
F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2023-24]
Disadvantages of FIFO:
a) As materials are charged at old prices, cost of production may lag behind current
economic values.
b) This method does not permit comparability since different materials may be charged at
different period of time
c) When prices fluctuating, this method involves cumbersome record keeping.
2) Last in first out (LIFO) Method – excluded from syllabus
3) Simple Average Method – omitted from syllabus
4) Weighted Average Method (WAM): This method give due weightage to the quantities held
at each price when calculating the average price. The weighted average price is calculated
by dividing the total cost of material in stock, from which the material to be priced could
have been drawn, by the total quantity of material in that stock. The simple formula is
weighted average price at any time is the balance value figure divided by the balance units
figure.
Advantages of WAM:
a) This method smoothens out the effect of fluctuations in purchase price.
b) A new issue price is calculated at the time of each new purchase and not at the time of
each issue.
c) No unrealized profit or loss arises by the use of this method.
Disadvantages of WAM:
a) Issue prices may not be at the current market prices.
b) The method calls for many calculations where purchases are made frequently.
c) To avoid errors, the average price must be calculated to a sufficient number of decimal
points which makes calculations tedious.
d) Excessively high or low prices paid in the past are reflected in the average for a
considerable time after expensive or inexpensive material has been consumed.
******************** ALL IS WELL ********************
PRACTICAL QUESTIONS
Example 1:
Two materials A and B are used as follows:
Minimum usage 5,000 units per week each
Maximum usage 15,000 units per week each
Normal usage 10,000 units per week each
Re-order quantity A – 60,000 units B – 100,000 units
Delivery period A – 4 to 6 weeks B – 2-4 weeks
Calculate the various stock levels.
SVKM’s NMIMS, Navi Mumbai Campus 7|Page
F.Y.Bcom (Hons) – Semester I – Cost Accounting [Academic Year 2023-24]
Example 2: Calculate Economic Order Quantity from the following information:
Estimated requirement per annum 60,000 units
Cost per unit Rs. 20
Ordering cost per order Rs. 12
Carrying cost 5% p.a.
Example 3: (Do it yourself)
Two components X and Y are used as follows:
Normal usage 6,000 units per week each
Maximum usage 9,000 units per week each
Minimum usage 3,000 units per week each
Re order quantity X–48,000 units; Y-72,000 units
Re order period X- 4 to 6 weeks; Y – 2 to 4 weeks
Calculate the various stock levels for both materials
Example 4: The annual demand for a raw material is 6,400 units. Inventory carrying cost is Rs. 1.50 per unit
per annum. If the cost of one procurement is Rs. 75, determine:
(a) Economic order quantity. (b) Number of orders per year. (c) Time between two consecutive orders
Example 5: (Do it yourself)
Determine the EOQ from the following information:
Annual consumption 12,000 units
Cost of ordering Rs. 15 per order
Cost of material Rs. 1.25 per unit
Carrying cost 20% p.a.
Example 6: (Do it yourself)
From the following information you are required to calculate for each product:
(a) Re-order level (b) Maximum stock (c) Minimum Stock and (d) Average Stock
Particulars Material X Material Y
Average consumption per week 500 500
Minimum requirement per week 250 250
Maximum usage per week 750 750
EOQ 3,000 5,000
Replacement time 4 to 6 weeks 2 to 4 weeks
Example 7: Shriram enterprises manufactures a special product ZED. The following particulars were
collected for the year 2017:
a) Monthly demand for ZED – 10000 units
b) Cost of placing an order Rs. 1500/-
c) Annual carrying cost per unit Rs. 30/-
Details of Raw Material Consumption:
d) Normal Consumption 500 units per week
e) Minimum Consumption 250 units per week
f) Maximum Consumption 750 units per week
g) Re order period 4-6 weeks
Compute the Re-Order Quantity, Re-order Level, Minimum level, Maximum level and Average Stock level
from the above information assuming 50 weeks for one year.
Example 8:
In manufacturing its product Z, a company uses two raw materials A and B, in respect of which the following
information is supplied.
One unit of Z requires 10 kgs of A and 4 kgs of B materials. Price per kg of A material is Rs. 10 and that of B is
Rs. 20. Re order quantities of A and B materials are 10,000 kgs and 5,000 kgs. Re order level of A and B
materials are 8,000 kgs and 4,750 kgs respectively. Weekly production varied from 175 units to 225 units
averaging 200 units. Delivery period of A material is 1 to 3 weeks and B material is 3 to 5 weeks.
Compute the various stock levels.
Example 9:
a) The monthly demand of a Product is 5000 units. The company requires 50 kg of raw material for each unit
of the product. The supplier of the said raw material, M/s Shah and Company, sells the said raw material
at a cost of Rs. 250 per unit. The ordering cost paid per order by the company is Rs. 400 and the storage
cost per unit per annum is Rs. 24. You are required to calculate the Economic Order Quantity and number
of orders during the year. (F.Y. B. Com (Honours) – Final Exam – November 2018)
b) A company manufactures 1500 units of product EXE per month at a cost of Rs. 150 per unit. It requires ten
units of raw material to manufacture one unit of EXE. The raw material is supplied to the company at Rs.
12 per unit. The supplier is willing to give a discount of Rs.2 if the company commits to buy at least 1,00,000
units per annum. The cost of procurement for the company is Rs. 50 for every 2 orders. The cost of storage
is 10% p.a. You are required to find the optimum quantity that the company should order to minimize
cost. (F.Y.B. Com (Honours) – Mid Term Exam – November 2019)
Example 10: Find the Annual Inventory Cost for Eg 9 (a) and (b)
Example 11: Maxis Enterprises manufactures a special product MAC. The following particulars were collected
for the year 2021:
a) Monthly demand for MAC – 15000 units
b) Cost of placing an order Rs. 1600/-
c) The Cost per unit of Raw materials is Rs. 200
d) Carrying Cost is 2.5% per quarter
e) Normal Consumption 500 units per week
f) Minimum Consumption 250 units per week
g) Maximum Consumption 750 units per week
h) Re order period 4-6 weeks
Assuming a period of 50 weeks, you are required to calculate all the Material Levels and the Annual
Inventory Cost of the company. Would it be beneficial for the company to order 4000 units per order
instead?
(Note: Do not round off partial orders) (January 2022 – TEE – FYBCom (Honours)
Example 12: Harsha Limited produces a product which has a monthly demand of 4000 units. The product
required a component X which is purchased at a cost of Rs. 20 p.u. For every finished product, one unit of
component X is required. The ordering cost is Rs. 120 per order and the holding cost is 2.5% per quarter. You
are required to calculate:
(i) Economic Order Quantity.
(ii) If the minimum lot size to be supplied is 4000 units, what is the extra cost to be incurred?
“You need to battle with fear of failure to achieve your goals in life.”
Example 19:
The following were the receipts and issues of material ZED during March 2005.
March Particulars
1 Opening balance – 1100 units Rs. 60 per unit
3 Issue - 140 units
4 Issue - 250 units
8 Issue – 210 units
13 Received from vendor 400 units at Rs. 59 per unit
14 Refund of surplus from a work order 30 units at Rs. 58 p.u.
16 Issue 350 units
20 Received from vendor 480 units at Rs. 62 per unit
24 Issue 608 units
25 Received from vendor 640 units at Rs. 60 per unit
26 Issue 524 units
28 Refund of surplus from a work order 24 units (issued on March 3)
31 Received from vendor 150 units at Rs. 64 per unit
From the above, write the Stores Ledger Account on FIFO and weighted Average Basis.
Example 20:
The EOQ of a particular Company during a particular year was 2100 units. The holding cost comes to 2% p.a.
The cost per unit of the raw material is Rs. 500. Calculate the Annual Ordering Cost for the company for the
given year. (BCom (H) Mid term Examination – November 2022)
“Just when the caterpillar thought the world was ending, he turned into a butterfly.”