MATERIAL CONTROL AND COSTING

Material is defined as all the tangible material assets of an organization other than its fixed assets. It is
also called stocks, stores, merchandise and inventory. Stock consists of :
i. Raw material
ii. Work –in – Progress
iii. Finished goods
iv. Merchandise ready for sales
v. Materials to be incorporated into a finished product (i.e. component parts)
vi. Consumables such as stationeries

NATURE AND CLASSIFICATION

Material is the same thing as stock or inventory. Its classification will depend on the nature of the
business. What is material items to some business may be assets to some other business. A company
manufacturing car will have it as stocks for sales while some company into another business will have
those cars as assets.

MATERIAL MANAGEMENT
This is about planning on how to get materials for the company. It boarders on the type of stocks to buy,
where to buy, when to buy and for how much

CATEGORIES OF STOCK COSTS

There are four categories of stock costs which makes the total cost of a stock:
1. Purchase Cost: This is the amount paid for each stock item. It could be fixed and it cloud vary. It
is fixed if no discount is given while it varies if discount is given.

2. Ordering Cost: This is the cost incurred to make order for the stocks to be purchased. It includes
the following:
 Transportation cost i.e. carriage inward
 Administrative costs associated with purchasing, accounting and receiving goods
 Set-up and tooling costs of production run for goods manufactured internally

3. Holding / Carrying Cost: This is the cost of keeping the stocks in the ware-house. It includes the
following:
 Forgone interest on capital
 Storage charges e.g. rent, light and heating
 Store administration cost i.e. staff salary, equipment maintenance and handling charges
 Insurance and security
 Pilferages and damages
 Stock taking
 Handling costs e.g. cost of packing and unpacking stocks
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 4. Stock out Cost: This is the cost of running out of stock. It includes the following:
 Loss of contribution
 Loss of future sales
 Loss of customer goodwill
 Loss of production stoppage i.e. idle time payment
 Labour frustration over stoppage which may lead to labour turnover
 Extra cost of urgent replenishment purchases

PURCHASING PROCEDURES
Generally the following purchasing procedures are to be followed:
Requisition Form: This is the document used to initiate purchases or place an order. It is issued from the
store or by the production department or the desiring department where the material does not pass through
the store to the purchasing department. The following essential information should be included in the
form:
 Name of the department making requisition
 Date of requisition
 Requisition No.
 Code and description of Material
 Quality and quantity required
 Expected date of delivery
 Authorized signature

Purchase Order: This is the document used to order for materials needed. It is sent from the purchasing
department to the supplier. The document is signed by the authorized signatory. The following essential
information must be included in the form:
 Description of the materials required including quality
 Quantity and price
 Name and address of the supplier
 Required date of delivery
 Signature of the purchasing officer

A copy of the purchase order is sent to the following departments:

i. Department making requisition i.e. for the department to know that an order has been placed
ii. Stores department i.e. for preparation for the receipt of the goods on delivery date
iii. Accounts i.e. for purpose of payment

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Receipt and Inspection of Materials
When goods are received, they are checked for quantity and description against the delivery note (DN)
and purchase order. If they are satisfactory, a Goods Received Note (GRN) is prepared. If the goods do
not meet the specification or purchase order, they are returned immediately to the supplier if possible. If
not, they are stored separately and marked to be returned. Rejected goods should be covered by a debit
note.

Payment to Supplier
The final stage is the payment to the4 supplier which is done in the accounts department. The supplier’s
invoice is received by the purchasing department. This invoice is compared with the delivery note,
purchase order form; goods received note and inspection note (where necessary). The quantity, price and
discount are also checked after which the invoice is forwarded to the accounts department for further
verification. If satisfactory, the accounts department will certify the invoice for payment according to the
terms of payment agreed.

Recording of Stores
There are two main documents for recording the quantity of materials held in the store. They are:

The Bin Card or Stock Card Kept in the Store

A bin card shows the level of inventory of an item at a particular stores location. It is kept with the actual
inventory and it is updated by the storekeeper as inventories are received and issued. It is kept in the store.
A typical bin card is shown below:
BIN CARD

Bin number -------------------- Location -----------------------

Material code --------------------- Store ledger number -----------------------
Description ---------------------
Receipts Issues Balance
Date GRN No. Quantity Date Requisition Quantity Inventory
No Balance

The bin card does not show the monetary value of materials. It is just the quantity received and issued.

The Stores Ledger Card or Account

The stores ledger card or account is kept in the accounting office and form part of the accounting system.
This shows the monetary value of materials received and issued. A typical store ledger is shown below:

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 STORE LEDGER CARD / ACCOUNT

Material ----------------------
Re-order Level ------------------------------
Code ----------------------
Re-Order Quantity ------------------------------
Maximum Quantity ------------------------------
Minimum Quantity ------------------------------
Date Receipts Issues Inventory Balance
GRN Qty. Unit Amt. Requisition Qty Unit Amt. Qty. Unit Amt.
No. Price No. Price Price
N N N N N

Perpetual Inventory System

This is a system of stock control where records are kept as a perpetual record of receipts and issues of
materials. This is to say that the stock record is updated each time there is receipt or issue of material. This
makes it possible to know the stock level at any point in time. The two perpetual inventory records are the
bin card and the store ledger card

Stock Taking
This is the physical counting of materials in the store. There are two types of stock taking methods
namely:
1. Annual / Periodic Stock Taking
This is a method of stock taking that counts and value stocks at the end of a given period usually
quarterly, ½ yearly or annually

Advantages
i. It is less expensive
ii. The inconveniencies of regular or frequent stock count is avoided

Disadvantages
i. It may require a disruption of operation activities at the end of the year when stock take is
to be taken
ii. The rate of inaccuracies may be high due to large no. of work involved
iii. It may increase theft and pilferages that ought to have been noted earlier and corrected

2. Continuous Stock Taking

This is the counting of physical quantity of materials in store s regularly, a few at a time, until all
items are checked at least once a year. Stock items are counted at frequent intervals on a random
rotational basis and the results of the counts are reconciled with the corresponding figure on the
bin card. This stock take is usually carried out by an expert who is not a member of the store
department
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 Advantages
i. It is deterrent to pilferage and theft
ii. The closure of store for an annual stock count is avoided
iii. Discrepancies are discovered earlier and remedied more promptly
iv. The store system is kept constantly under review
v. It enhances effective stock control

Disadvantages
i. It is expensive to operate

Causes of Stock Discrepancies

i. Incomplete entries causes by non completion of original document
ii. Casting errors on the stock records
iii. Over or under issue due to carelessness of the issuing officer
iv. Recording material in the wrong stock record
v. Movement of stock without proper documentations
vi. Pilferages and theft
vii. Loss due to breakage and evaporation
viii. Inaccuracies in the stock count caused by:
a) Omission b) Double counting

STOCK CONTROL LEVEL

The level of stock held will depend on a number of variables which have cost implications. Management
must make decision about the control of stock level to minimize cost and also to avoid running out of
stock so that profit can be maximised. The following stock levels need to be considered:
i. Re-order stock level
ii. Maximum stock level
iii. Minimum stock level or buffer stock or safety stock level
iv. Re-order stock quantity or Economic Order Quantity
v. Average stock

Illustration 1
The following data relates to Good work company Ltd. with respect to material AY4
 12,000 units of material will be used everyday for a 360 days year
 It will cost N500 to place each order
 The cost of one unit of AY4 is N120 and it will cost 10% of this amount to hold each stock
 Daily usage will not exceed 12,500 units and not less than 11,500 unit
 It takes the supplier maximum period of 4 days to deliver but the shortest delivery period could be
2 days
 Economic Order Quantity is 18,974 units
Required: Calculate the various stock levels
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The above example will be used to illustrate and explain the various stock levels as follows:

Re-Order Level
This is the level at which an order will be placed for additional supply of materials to avoid stock out.
When inventory reach this level an order should be placed to replenish inventories. It is influence by:
 Rate of consumption and
 Delivery period

It is calculated as:
ROL = maximum usage x maximum lead time (lead time is the delivery period)

Maximum Stock level

This is the maximum level of stock that can be held at any given time. It also acts as a warning level to
management that inventories are reaching a potentially wasteful level. It is influenced by the following
factors:
 Storage facilities
 The nature of stock such as its Perishability and seasonability
 The cost of storage
 The rate of consumption
 The Re-order Quantity / EOQ
 The delivery period
 The Re-order level
It is calculated as:
Maximum Stock level = ROL + EOQ – [minimum usage x minimum lead time]

Minimum Stock Level

This is the lowest level at which stock may be allowed to fall. It is also called the safety stock and buffer
stock. It is a warning level to draw management attention to the fact that inventories are approaching a
dangerously low level and that stock outs are possible. It is influenced by the following factors:
 Rate of consumption
 Delivery period i.e. the lead time
 The re-order level
It is calculated as:
Minimum Stock level = ROL – [average usage x average lead time]

Re-Order Quantity / Economic Order Quantity (EOQ)

This is the optimum quantity that should be ordered each time an order is placed. It is to optimize material
cost. The cost of material is made up of purchase cost, ordering cost, holding cost and stock out cost.

EOQ is calculated as: 2DCo

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 Cc
Where D = annual demand
Co = Ordering cost
Cc = Carrying cost

Assumption of EOQ
The following are the assumptions of EOQ:
i. No price discount is allowed
ii. Demand rate is constant
iii. Carrying cost is directly proportionate to the value of stock held
iv. No stock outs are allowed
v. Replenishment of stock is instantaneous

Average Stock Level

The formula for the average inventory level assumes that inventory levels fluctuate evenly between the
minimum inventory level and the highest possible inventory level (the amount of inventory immediately
after an order is received, i.e. safety stock + re-order quantity). It is calculated as:
Average inventory = safety inventory + ½ re-order quantity

Example 5.6 of Coping with Cost Accounting, page 86

Illustration 2
A large retailer with multiple outlets maintains a central warehouse from which the outlets are supplied.
The following information is available for product K
Average usage 350 per day
Minimum usage 180 per day
Maximum usage 420 per day
Lead time for replenishment 11 – 15 days
Re-order quantity 6,500 units
Re-order level 6,300 units

Required:
a) Based on the information above, what is the maximum level of inventory?
b) What is the buffer stock?

Illustration 3
The annual demand for an item is 120 units. The item costs N500 a unit to purchase, the holding cost for
one unit for one year is 16% of the unit cost and ordering costs are N300 per order. The supplier offers a
3% discount for orders of 60 units or more, and a discount of 5% for orders of 90 units or more

Required
Calculate the cost minimizing order size
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METHODS OF MATERIAL ISSUES, PRICING AND VALUING STOCKS:
1. First –in First- out (FIFO) Pricing Method
The FIFO method is based on the assumption that materials are issued out to production according
to how they are received i.e. the materials received earlier are issued out to production as they
come to the store. This means that the oldest costs of goods are assigned to the units that are
transferred out of store first and the closing stock is measured by the cost of units most recently
acquired.
2. Last-in First-out (LIFO) Pricing Method
This method assumes that the latest materials received are issue out to production first. This means
that the latest cost of materials are assigned to stock issued to production while closing stocks are
valued using the oldest cost of materials

3. Weighted Average Pricing Method

This method uses the average price of FIFO and LIFO. It averages prices after weighing different
prices by their quantity with each receipt of material. The weighted average price is calculated
each time there is a fresh receipt of goods and this price is used to value the issue of materials to
production and closing stocks

4. Replacement Cost
This method uses current market price to issue material to production and value closing stock
regardless of how much the stock were actually bought. It is mostly used for short term decision
making.