The cost of production of any articles , constitute an important component of  the cost of  production. They account for nearly 60 per cent of the cost of production of a large number of private and public sector organisations.

The materials can be divided into two categories:

 The materials which can easily be identified and  attributed  to the individual  units are known as 'direct materials'. These materials form part of the finished product. Leather used in the manufacture of shoes and yarn required for the production  of cloth are examples of direct materials. All costs which are incurred to obtain direct materials are known as 'direct material cost'

. .

Indirect materials, on the other hand do not form part of the finished product and cannot be conveniently and accurately allocated to a particular unit of product. Examples of such materials are: consumable stores, cotton waste and lubricating oils, required for the maintenance of machines ,etc. costs associated with indirect  materials arc known as costs'.

 

Material control may be defined as the regulation of the functions of an organisation relating to procurement, storage and usage of materials in such a way as to maintain  an even flow of production without excessive investment in material stock. Thus, materials control involves control of  three important  functions viz. procurement, storage and usage. It has been rightly pointed out  that just as the handling of  cash is  of  utmost important  in  the case of  a Non-Manufacturing business, an efficient handling of materials is of vital importance in tha case of a manufacturing business.

 

The following are the main objectives of material control.

There should be a continuous availability of all types of materials in the factory so that production may not be help up for want of any material.

Over stocking of materials should be avoided. By doing so the various losses caused by overstocking can be avoided.

 

Materials should be purchased on the most favourable terms. This helps in effecting maximum economy in the cost of buying of course, the quality should not be sacrificed at the cost of lower price.

Purchase of materials should be of the right quality consistent with the standards prescribed in respect of the finished goods.

 

 

Materials should be properly stored so as to prevent losses during storage.

The  management should'be frequently provided cost of  materials and the availability of stock.

Advantages The main advantages of a good system of material control are as follows:

1) It ensures unrestricted and continuous supply of materials and may be greatly helpful in preventing production delays.

 2) It minimises capital investment in the stock of rnaterials. 

3) It considerably reduces the cost of storage and issuing of materials. 4) It eliminates wastage and loss of material arising on account of spoilage, pilferage, theft, etc.

5) It is immensely helpful in introducing the system of perpetual inventory control by which accurate ascertainment and valuation of closing stock are facilitated.

6) It ensures the purchase of materials at reasonable prices. ' 

7) It aids management in initiating and formulating proper purchase policies regarding materials.

 

Materials control extends to all spheres of materials management viz., buying, receiving, inspection, storage consumption and accounting. The following are the basic requirements of a good system of materials control. 

1) There should be proper co-ordination of all departments which are involved in the purchasing, receiving, testing, approving, storage of materials and payment of price. 

 2) The purchase of materials should be centralised. 

3) Proper forms should be used with regard to receipt, issue and transfer of materials from one job to another. 

4) There should be a budget for materials and supplies so that economy in I purchasing and use of materials is realised. 

5) A system of internal check should be introduced in order to have proper check on the purchases of materials, and supplies. 

6) A well organised system of storage of materials should be undertaken in order to avoid deterioration, pilferage, wastage and evaporation of materials. 

7) There should be a system of perpetual inventory so that it is possible to find out the quantity and value of materials in stock at any point of time.

 8) Minimum limit for each item of material should be fixed below which the stock is not allowed to drop. Similarly, the maximum limit should be fixed above which the stock should not be kept. 

9) There should be a proper system for the issue of materials so that there will be delivery of materials*on requisition to the department, processes or jobs in the right quantity and at the moment they are needed. 

10) Information about availability of materials should be made continuously available to the management so that planning of production may be done keeping in view the inventory balances in stores. Information about obsolete and defective stock should also be given to the management from time to time so that steps may be taken for the disposal of such stock.

 

 Under centralised purchasing purchases are made at one central point for the whole organisation and from that central point materials are issued to respective departments or jobs as, and when required. In other words, centralisation of purchasing refers to the placement of authority for the whole purchasing function in . the purchasing department headed by the purchase manager. In medium sized and big companies purchasing function is generally centralised.

Decentralised purchasing is the reverse of centralised purchasing. Each department makes its own purchases. Decentralised purchasing is also known as 'localised purchasing.

It can be said that centralised purchasing is decidedly better than decentralised purchasing. However, neither of them is considered wholly satisfactory in the case of all types of concerns. Centralised purchasing is eminently suited to a concern operating only one plant. It is also suitable for a concern operating two or more plants located not far away from one another and producing more or less homogeneous products. However, a manufacturing concern which operates several branches or factories at different places and manufactures different products requiring different types of materials, can have decentralised purchasing and different factories can meet their requirements by making purchases in the local markets.

 

 Although the details of the purchase procedure may vfery with individual concerns, the foUowing.are.the various steps which are usually followed in connection with the purchase of materials.

 1 Purchase Requisition

 A form known as, 'purchase requisition' is commonly used as a formal request to the purchase department to order goods or services. The purchase requisition serves the dual purpose of authorising the purchasing department to make a purchase and provides a record of the description and quantity of materials required. The purchase requisition is prepared by the storekeeper for regular stock materials and by the departmental head for special materials not stocked as regular items. Regular purchase requisitions are prepared when stock is reduced to re-order level, i.e., the level when the order for replenishment should be p,laced. The requisition is approved by an executive. Purchase requisitions are generally prepared in triplicate. Ttre original copy is sent to the purchase department, the record is retained by the storekeeper Or the executive initiating the purchase requisition and the third copy is sent to the costing department. The purchase requisition contains the requisition number, date, department, code number, description and quantity of materials required, signature of the person initiating the requisition and signature of one or more executives approving the purchase requisition.

2. Selecting the Supplier

 Having decided to purchase the material, the purchase department invites tenders or quotations for the supply of materials. On receipt of the quotations from the suppliers, a ccrmparative statement known as 'schedule of quotations' should be prepared so that a suitable supplier may be selected. .

 While making the selection, the purchase manager should not machanically identify the supplier whose quotation is the lowest. He should judiciously decide with whom he has to place the order and in doing so he must consider such factors as price, quality, time of delivery, dependability of the supplier, discount, credit facility, terms of payment, etc.

3. purchase Order After choosing the supplier, the purchase department prepares a purchase order for the supply of stores. The order is the written authorisation to the supplier to supply the particular material or materials. The purchase order is an important document not only from the legal point of view, but for the accounting point of view also. It is the evidence of the contract between the buyer and the supplier that binds both the buyer and the supplier to the terms under which the order is placed. It also gives authority to the receiving department to receive the materials ordered for and to the account department to accept the bill from the supplier for payment. 

 The purchase order should contain such particulars as date, name and address of the supplier, description and specification of the material, quantity ordered, date, time , and place of delivery, price, terins of payment, transport charges, packing and shipping instructions, the name and address of the buyer, and the signature of the purchase manager. , The number of copies of the purchase order depends upon the size of the organisation. A large concern usually issues five copies. of these the original copy is , sent to the supplier, the second to the receiving department, third to the department initiating the purchase requisition, the fourth to the accounts department and the fifth copy is retained iq the purchase department. The copy retained in the purchase department is used to check the progress of the order and to ensure that the delivery promise's are adhered to.

4. Receiving and Inspection of Materials

 The receiving department is responsible for taking delivery of packages and to get a physical verification of the contents. When the packages are received, the receiving official gets them opened and makes a detailed verification of the contents. After the contents of the packages have been checked, the details of the materials received are entered in a Goods Received Note. Five copies of the note are prepared. One copy is kept by the receiving department while the remaining copies are routed to the purchase department, the department originating the purchase requisition, the stores department, and the accounts department.

Where the factory has a separate inspection department, its main function is confined to testing the material received, for quality and specifications. The engineer or the . chemist may be called to check the quality of the materials. He is to ensure that the . quality is according to the purchase order. After checking the quality of the materials, the department will submit a report as to the quality and if some of the materials are

rejected, the reasons therefore. An unfavouable inspection report is utilised by thepurchasing department in obtaining adjustments or an authority for the return of goods to the vendor. This forms the basis for' the issue of a debit note.

 5 Checking and Passing of Bills for Payment Invoice is the document giving details of goods supplied and the amount to be paid. Invoice received by the purchase department is forwarded to the Accounting Department to check the authenticity as well as the arithmetical accuracy. The quantity and the price mentioned in the invoice are checked with reference to goods received note and the purchase order respectively. For Adjustment of discrepancies. the inspection report and goods returned note should be compared with the invoice, It is equally necessary to check extensions and totals. If the contents of the invoice are found to be correct, an endorsement to that effect is made on it with a rubber stamp. With the signature of the purchase manager, the invoice is passed on to the accounts department for payment.

 

After the purchase, receipt and inspection of materials, the next most important step in the process of material control is concerned with' the storage of materials which is termed as 'storekeeping', Storekeeping is that aspect of material control which is concerned with the physical storage of goods. For carrying the task of storekeeping, a separate stores department under the charge of a storekeeper is set up. The storekeeper should have the technical knowledge and experience in stores routine and the ability of organising variety activities relating to the storage of goods.

 

Lay-out refers to the internal arrangement or placement of materials inside the stores. It aims at effective utilisation of space available for storage of materials. The stores should be divided into racks which should be sub-divided into small spaces. All these spaces are known as bins. For every kind of material a bin is allotted. All bins should be serially numbered.

 

All items in stores are meant issuance to various production departments. The procedure for the issue of materia.1 is normally laid down by the management.

The storekeeper should not issue the materials unless a properly authourised material requisition is presented to him. The requisition is prepared by the foreman or the head of the department. It is prepared in triplicate, two copies are sent to the stores departm&t and the third copy is retained by the requisitioning department for its own reference. On receipt of the materials requisition, the storekeeper issues the necessary materials against the signatures of the person receiving the materials. One of the copies of the materials requisition is used by the storekeeper for making the necessary entries in the bin card. The other copy is sent to the costing office for pricing the issues and making the necessary entries in the stores ledger.

A bill of materials is a standard list (also called specification list) of all materials required for a particular work order, job or process. It is prepared by the production department on receiving the order. It can be used as a substitute for materials requisition. It provides advance intimation to the storekeeper about the requirements of different jobs or work orders. Description

The bill of materials serves the following purposes: 

1) The clerical work involved in preparing a number of requisitions is considerabably reduced and there is economy in the use of stationery. Stores ledger folio No. 

2) The cost of transportation involved in receiving the required quantity of every type of material is also proportionately reduced since all the materials required for a particular job can be transported to the receiving department only once. 

3) It serves an advance intimation to the storekeeper and constitutes an authorisation for the issue of materials. Rate 

4) It may also be used as an authorisation for procurement of materials if these are not available in stock. Thus it eliminates the need for the issue of purchase ' requisitions for procuring materials not available in stock. Amount 

5) It may be used as a basis for passing accounting entries in the stores ledger.

 6) The procurement and issue of materials can be planned in advance to avoid delays in production and deliveries.

Treatment of surplus Materials

The document used for return of excess materials to the stores is known as 'materials returned mote' or 'shop credit note'. The form of the materials returned note is similar to that of material requisition slip. But to distinguish between the two, forms of different colours are generally used. The materials returned note is prepared in duplicate. One copy is retained by the department returning the material and the other copy is kept by the storekeeper who gets it along with the material returned. The materials returned note is forwarded to the costing office where the necessary credit for value of materials returned is given to the particular job. Transfer of materials: Sometimes excess materials in relation to a job or work order may become useful to another job. In such a case, a material transfer note should be prepared transferring the material from one job to another. 

 

For the purpose of exercising selective control over materials, manufacturing concerns find it useful to divide materials into three categories. An analysis of the annual consumption of materials of any organisation would indicate that a handful to top high value items (less than 10 per cent of the total number) will account for a substantial portion of about 70 per cent of total consumption value. 

Similarly, a large .number bottom items (over 70 per cent of the total number of items) account for only about 10 per cent of the consumption value. Between these two extremes will fall those items the percentage number of which is more or legs equal to their consumption value.

 Items in the top category are treated as 'A' items, items in the bottom category are called as 'C' category items and the items that lie between the top and the bottom are called 'By category items. Such an analysis of materials is known as 'ABC analysis' or 'Proportional parts value analysis'.

Critical i.e., high value items deserve very close attention and low value items need tn be devoted minimum expense and effort in the task of controlling inventories. The material manager by concentrating on 'A' class-items is able to control inventories and show visible results in a short span of time. By controlling 'A' items and doing a proper inventory analysis, obsolete stocks are automatically pinpointcd. ABC analysis also helps in reducing the clerical costs and results in better planning . and improved inventory turnover. ABC analysis has to be resorted to because equal attention to A, B and C items will not be worthwhile and would be very expensive.

The following steps will explain to you the classification of the items into A, R and C categories. 

 I) Calculate the unit cost and the usage of each material over a given period. 

2) Multiply the unit cost by the estimated usage to obtain the net value. 

3) List out all the items by rupee annual issues and arrange them in the descending  value. 

 4) Accumulate value and add up number of items and calculate percentage on total inventory in value and in number.

5) Draw a curve of percentage items and percentage value.

 6) Mark off from the curve the rational limits of A,B and C categories.

Fixation of certain levels for each item of materials is one of such techniques. The following levels are generally fixed: 

1) Minimum stock level 

2) Maximum stock level 

3) Re-ordering level 

4) Danger level

 

Re-ordering level

This level normally lies between the maximum and minimum stock level. This level will usually be higher than the minimum stock level to cover for emergencies as abnormal usage of material or unexpected delay in delivery of fresh supplies. The fixation of this level normally takes into consideration the lead 'time (period of supply or re-order period), rate of consumption and the economic ordering quantity.

Maximum Consumption = The maximum rate of material consumption in

production activity

Maximum Re-order period = The maximum time to get order from supplier  to the stores

This can also be calculated alternatively as below:

ROL = Minimum Stock Level + (Average Rate of Consumption × Average Re- order period)

Minimum Stock Level = Minimum Stock  level that must be  maintained  all the time.

Average Rate of Consumption = Average rate of material consumption in

production activity. It is also known as normal consumption/ usage

Average Re-order period = Average time to get an order from supplier to

the stores. It is also known as normal period. (Re-order period is also known as Lead time)

 

Re-Order Quantity: 

Re-order quantity is the quantity of materials for which purchase requisition is made by the store department. While setting the quantity  to be re-ordered, consideration is given to the maintenance of minimum level of stock, re-order level, minimum delivery time and the most important the cost. Hence, the quantity should be where, the total of carrying cost and ordering cost be at minimum. For this purpose, an economic order quantity should be calculated.

 Economic Order Quantity (EOQ): The size of an order for which total of ordering and carrying cost are at minimum.

Ordering Cost: The costs which are associated with the purchase or order of materials. It includes cost to invite quotations, documentation works like  preparation of purchase orders, employee cost directly attributable to the procurement of material, transportation and inspection cost etc.

Carrying Cost: The costs for holding/ carrying of inventories in  store. It includes  the cost of fund invested in inventories, cost of storage, insurance cost, obsolescence etc.

The Economic Order Quantity (EOQ) is calculated as below:

EOQ =√2AS/C

Annual Requirement (A)- It represents demand for Raw material or Input for a year.

Cost per Order (O) - It represents cost of placing an order for purchase.

Carrying Cost (C) – It represents cost of carrying average inventory on annual basis.

Assumptions underlying E.O.Q.:

The calculation of economic  order of material to be purchased is subject to the following assumptions:

1. Ordering cost per order and carrying cost per unit  per  annum are known and they are fixed.

2. Anticipated usage of material in units is known.

3. Cost per unit of the material is constant and is known as well.

4. The quantity of material ordered is received immediately i.e. the lead time is zero.

 

Maximum stock level It is that quantity of material above which the stock of any item should not be allowed to exceed. The main object of fixing the maximum stock level is to avoid undue investment in stock and to use the working capital in a proper way. Maximum stock level is fixed by taking into consideration the following factors: 

I) Amount of working capital available

 2) Normal rate of consumption of materials during the lead time 

3) Time necessary to obtain deliveries

4) Availability of storage space 

5) Economic ordering quantity 

6) Cost of carrying the inventory 

7) Possibility of loss due to evaporation, deterioration etc. 

8) Extent to which price fluctuations may be important.

 9) Possibility of change in fashion, habit etc., which may necessitate the change in the specification of materials 

10) Incidence of insurance costs which may be important for some materials. The following formula is generally used for the calculation of maximum stock level. 

Maximum stock level = Re-order level + Re-order quantity-(Minimum consumption X Minimum re-order period) 

 

Danger level 

This is generally a level below the minimum level. When stock reaches this level, urgent action is needed for replenishment of stock. If no emergency steps are taken to restock the materials, the stores will be completely exhausted and normal production stopped. At this level no further issues are made by the storekeeper except on special requisition approved by the works manager. The level is generally calculated by taking into account the time required to get the materials by the quickest possible means of transport i.e., minimum time required for obtaining supplies from any possible source. It is calculated as follows:

Danger Level = Average consumption X Maximum re-order period for emergency purchases 

 

Average stock level 

Average stock level is usually calculated with the help of the following formula: 

Average Stock Level = Minimum Stock Level + 1/2 Re-order Quantity

Alternatively, it can be calculated as below:

                       Average Stock Level =   Maximum Stock Level + Minimum Stock Level

                                                                                        2

 

 Some quantity of stock may be kept for contingency to be used in case of sudden order, such stock is known as buffer stock.

           

Inventory Stock- Out

Stock out said to be occurred when an inventory item could not  be  supplied due to insufficient stock in the store. The stock- out situation costs to the entity not only in financial terms but in non-financial terms also. Due to stock out an entity not only loses overheads costs and  profit  but  reputation (goodwill) also due to non-fulfilment of commitment. Though it may not be a monetary loss in short term but in long term it could be a reason for financial loss.

While deciding on the level of inventory, a trade-off between the stock out cost and carrying cost is made so that overall inventory cost can be minimized.

 

Stores Records

One of the main functions of the storekeeper is to maintain records for receipts, issues and balances of various items of materials. Bin card and stores ledger are the two important stores records that are generally kept for making a record of the various items of stores.

Bin Card

 A bin card provide a quantitative record of the receipts issues and balance of material. A bin is a place where the goods are stored. A bin may be a shelf, an almirah, open space etc. depending upon the nature of .the commodity. These cards are usually attached to or place near the bin so that receipts and the issues may be entered therein as soon as they take place. Separate bin cards are prepared for each item of stores and if two different materials are kept in one almirah two bin cards one for each item are prepared, treating the almirah as two bins. The bin card provides a continuous record of the stock in each bin and assist the storekeeper to control the stock. For each material the maximum stocks to be held are noted on the card.

Stores ledger 

 This ledger is kept in the costing department and is identical with the bin card except that the receipts, issues and balances are shown along with their money values.  Stores ledger contains an account for each class of material and facilitates ascertainment of all details relating to the material in minimum time. It provides a continuous record of stores received and issued and discloses the balance in hand at any time both in quantity and value. It thus furnishes management with a perpetual inventory.

Stores ledger is generally maintained in the form of loose leaf cards. These cards should be serially numbered to obviate the risk of removal or loss.

Methods of costing-

The various methods used for the pricing of the material issues can be classified as follows:

 I) Actual Cost Methods 

a) First in First out (FIFO) 

b) Last in First out (LIFO)

 c) Specific price

 d) Highest in First out (HIFO)

 e) Base stock method 

II) Average cost methods 

a) Simple average 

b) Weighted average 

c) Periodic simple average

 d) Periodic weighted average

 e) Moving simple average

 f) Moving weighted average

III) Notional cost methods 

a) Standard price

 b) Inflated price 

IV) Market price methods

 a) Replacement price 

b) Net Realisable price

 

 Of the methods listed above, FIFO, LIFO and weighted average are the most common methods. 

Pricing methods in material

FIFO (First in First out): A method of pricing the issue of materials at actual cost in the chronological order of the purchases. 

This method is suitable in times of falling prices because the materials charge to production will be high while the cost of stock replacement will be low. But in case of rising prices, if this method is followed, the charge to production will be low leading to higher profits and higher tax liability.

Advantages 

 The following are the advantages of FIFO Method:

 1) It is simple to understand and easy to operate. 

2) Since materials are charged to production at actual cost, no profit or loss arises by reason of adopting this method. 

3) It is a good inventory management system since the oldest units are used first and inventory consists of latest stock.

 4) Closing stock generally represents fair valuation of stock, as it would consist of recent purchases of materials. 

Disadvantages 

This method suffers from the following disadvantages: 

1) The number of calculations complicates the accounts if the prices of material ' purchased fluctuate considerably and increases the possibilities of errors. 

2) Usually more than one price has to be adopted for each issue. 

3) Comparison of one job with another may be difficult because issues to one job . may be charged at prices different from the other. 

4) In a fluctuating market, the effect of the current market price is not revealed in the cost of issues.

LIFO (Last in First Out): A method of pricing the issue of materials at actual cost in of the latest purchase and when that lot is exhausted, the price of the previous consignment is adopted, and so on. 

Advantages The following are the advantages of pricing the material issues under LIFO method.

 1) It is simple and useful when transactions are few. 

2) Since issues are based on the actual cost, no profit nor loss arises by using this method. 

3) Production is charged at most recent prices so that cost of production reflects current price levels.

 4) During the period of rising prices, profits ace lowered down since production is charged at current prices. The tax liability is thus reduced.

 5) This method will iron out fluctuations in profits over a period of changing price levels. 

Disadvantages 

1) Sometimes more than one price has to be adopted for pricing a single requisition. 2) As in the case of FIFO method, calculations become complicated and cumbersome when rates of receipts are highly fluctuating. 

3) When prices are falling, it will lead to low charge to production.

 4) As in the case of FIFO method, a substantial difference is likely to be shown in the cost of two jobs, solely because the stock of one happened to be drawn a few minutes before those for the other. Thus it makes the comparison between different jobs very difficult.

 5) Closing stock is valued at a cost which does not represent current conditions.

 

 

The price which is calculated by dividing the total cost of materials in stock from which the materials are issued by the total quantity of materials in that stock.

Advantages 

1) It is logical and consistent

. 2) Cost comparisons are rendered easier. 

3) When price fluctuate considerably, it will smooth out fluctuations.

 4) Calculation of the new price arises only with the new receipt in stock, all subsequent issue are then charged at this price until the next Lot is received. 

Disadvantages 

1) This method requires tedious calculations. For instance to get the benefit of the method, average prices are to be calculated upto four or five decimal points which is very much laborious. 

2) Material cost does not represent the current prices. 

 3) Closing stock also may not represent current market prices.

 4) Fresh calculations will have to be made every time fresh purchases are made. This will mean much of arithmetical work and is likely to cause error.

 

Pricing of materials returned to vendors-

i) If FIFO method is followed, the price will be that of the oldest stock on the date of return.

 ii) If LIFO method is followed, the materials will be valued at the price of the latest receipt. 

iii) If the average price is followed, the returns should be valued at the average price.

Example-

Materials X and Y are used as follows: 

Minimum usage − 50 units each per week 

Maximum usage − 150 units each per week

 Normal usage − 100 units each per week 

Ordering quantities X = 600 units Y = 1,000 units

 Delivery period X = 4 − 6 weeks Y = 2 − 4 weeks 

Calculate for each material (i) Maximum level (ii) Minimum level and (iii) Ordering level.

 

Material X 

Ordering level = Maximum usage x Maximum delivery period 

= 150 x 6

 = 900 units. 

Minimum level = Ordering level - (Normal usage x Normal delivery period) 

= 900 − (100 x 5) 

= 400 units

Maximum level = (Ordering level + Ordering quantity) − (Minimum usage x Minimum delivery period) 

= 900 + 600 − (50 x 4

) = 1,500 − 200 

= 1,300 units 

Material Y Ordering Level = Maximum usage x Maximum delivery period 

      = 150 x 4 

      = 600 units 

Minimum Level = Ordering level − (Normal usage x Normal delivery period)

 = 600 − (100 x 3) = 300 units.

Maximum Level = (Ordinary level + Ordering quantity) - (Minimum usage x Minimum delivery period) = 600 + 1,000 − (50 x 2)

 = 1,600 − 100 = 1,500 units. 

Normal delivery period has been computed as follows: 

Material X = ( 4+ 6)/2 = 5 weeks 

Material Y =(2+ 4)/2 = 3 weeks