Cost Accounting

BBA LLB Semester 2

SVKM’s NMIMS Deemed-to-be University

Unit 2 & 3
costing and Control of
Material
Dr. Ashique Ali K A
Assistant Professor (Finance)
School of Law
SVKM’s NMIMS Deemed-to-be University
Hyderabad
 Material Cost and Material Control
• The term ‘materials’ generally used in manufacturing concerns, refers
to raw materials used for production, sub-assemblies and fabricated
parts.
• Material cost constitutes a prime part of the total cost of production
of manufacturing firms.
• Materials control aim aims at efficient purchasing of materials, their
efficient storing and efficient use or consumption. Therefore, it
enables smooth flow of production without interruptions while
preventing excessive investments in material stock. It consists of
control at two levels: Quantity control and financial control
 Objectives and Advantages of Material
Control
• Materials of the desired quality will be available when needed
• To enable efficient and uninterrupted production.
• Materials will be purchased only when need exists and in economic
quantities
• The investment in materials will be maintained at the lowest level
consistent with operating requirements.
• Purchase of materials will be made at the most favourable prices
under the best possible terms
• Materials are protected against loss by fire, theft, etc.
• To reduce handling time and cost of storing materials
 Types and Techniques of Material Control
1. Non selective inventory control techniques/ 2. Selective inventory control techniques/
quantitative inventory control techniques qualitative inventory control techniques
a. Level setting a. VED Analysis [Vital, Essential,
Desirable]
b. EOQ
b. ABC Analysis [Always Better Control]
c. JIT
c. GOLF Analysis [Government, Ordinary,
d. ITR (Inventory Turnover Ratio)
Local, Foreign]
e. ICR (Inventory Cost Report)
d. SOS Analysis [Season, Off Season]
f. Perpetual inventory system
e. HML Analysis [High value, Medium
g. Double bin system value, Low value]
f. SDE Analysis [Scarce. Difficult, Easy]
g. FSND Analysis [Fast moving. Slow
moving. Non-moving, Dead]
h. MRP (Material Requirements Planning)
Read more about the techniques from Textbooks and other
materials and prepare short notes
 Economic Order Quantity (EOQ)
• EOQ is the optimum re-order quantity
• If a company purchases materials in large quantities, the cost of carrying
the inventory would be high because of the high investment involved.
• Over-stocking requires more storage space, which, in turn, means, an
increase in insurance expenses, storage costs, and deterioration in quality
and depreciation in quantity
• On the other hand, if purchases are made in small quantities, frequent
orders would have to be placed for the purchase of materials.
• There will be the danger of stock outs also which may lead to production
stoppage and may be to purchasing materials on an emergency basis at a
higher price
• Hence, there should be a balance between carrying cost of inventory and
ordering cost while ordering materials.
 EOQ
• EOQ is the optimum quantity that should be purchased in each order.
• EOQ is the size of the order for which total cost of material is minimum.
• The total costs of a material usually consists of Buying Cost + Total Ordering Cost
+ Total Carrying Cost
• The EOQ is one where the cost of carrying inventory is equal or almost equal to
the cost of placing orders. Also at EOQ, the sum of carrying and ordering cost
would be the minimum
• The cost of carrying the inventory includes out-of-pocket costs such as warehouse
charges, insurance, heat, light, and losses due to spoilage, breakage, pilferage.
Besides, it includes the cost of capital invested in inventories.
• Ordering costs are the costs which are associated with the ordering of material. It
includes cost of staff posted for ordering goods, expenses incurred on
transportation, inspection expenses of incoming materials, etc.
• The carrying cost and ordering cost change in the reverse order. The ordering cost
decreases as the size of the order increases, as the number of orders will be
lower. However, carrying cost will be increased because of the large quantities
 Calculation of EOQ
2𝐴𝑂
• EOQ =
𝐶
• No. of orders to be placed in a year = Annual usage/EOQ
• Total ordering cost = No. of orders * Cost per order

• A = Annual Consumption of materials

• O = Cost of placing one order
• C = Carrying cost per unit per annum
• C = Cost per unit * per cent cost of carrying inventory
• Cost per unit is the purchase price per unit
 Various Costs Associated with EOQ
• Total Cost of Materials in a year = Purchase Cost + Associated Cost
• Purchase cost of Material = Annual Demand * Unit Price
• Associated Cost = Ordering Cost + Carrying Cost
• Ordering Cost = No. of orders per year * Ordering Cost per order
• Carrying Cost = (EOQ/2) * Carrying Cost per Unit
• Associated Cost = 2𝐴𝑂𝐶
• A – Annual Demand; O – Ordering Cost per order; C – Carrying Cost
per unit
• At EOQ; Total Ordering Cost = Total Carrying Cost
Problem 1
• Annual usage = 6000 units
• Cost of placing an order = Rs. 30
• Carrying cost as a percent of inventory = 20%
• Cost per unit of material = Rs. 5
• Calculate EOQ, No. of orders to be placed in a year, and total ordering cost

2𝐴𝑂 2∗6000∗30
• EOQ = = = 360000 = 600 𝑢𝑛𝑖𝑡𝑠
𝐶 1
• A = 6000 units
• O = Rs. 30
• C = 5 * 20% = Re. 1
• No. of orders = Annual usage/EOQ = 6000/600 = 10
• Total ordering cost = No. of orders * cost per order = 10 * 30 = Rs. 300
 Stock Levels
Re-order Level
• It is at the re-ordering level that the store keeper has to initiate the action
to replenish the material
• When to buy?
• Re-order level is a point or quantity level at which if materials in stores
reach, the order for supply of materials must be placed.
• It is fixed somewhere between maximum level and minimum level
Re-order Level (ROL) = Maximum Rate of Consumption x Maximum Re-
order Period
ROL = Minimum Level + (Normal Rate of Consumption x Normal Re-order
Period
ROL = Minimum Level + Consumption during Lead Time
 Stock Levels
Maximum Level
• It is the maximum quantity of material that can be held at any point
of time.
• The stock in hand should not exceed maximum level
Maximum Level = ROL + Reorder Quantity – (Minimum rate of
consumption x Minimum reorder period)
 Stock Levels
Minimum Level
• It is the lowest quantity of material that must be maintained at all
times to avoid stoppage of production. Also known as Safety stock.
• The stock in hand should not go below the minimum level
Minimum Level = ROL – (Normal rate of consumption x Normal
reorder period)
 Stock Levels
Average Level
Average Level = (Minimum Level + Maximum Level)/2

Or

Average Level = Minimum Level + ½ Re-order quantity

 Stock Levels
Danger Level
• It is usually fixed below the minimum level.
• It is the level at which normal issue of raw materials are stopped and only
emergency issues are made.
• When it is reached, urgent actions are required for new purchase of
materials.
• Sometimes, danger level can be fixed between minimum and re-order level
to act as a warning level.
Danger Level = Normal rate of consumption x Maximum re-order period for
emergency purchase
Danger level = minimum consumption X minimum re-order period
 Stock Levels
• Re-order period is also called lead time and it is the time taken to
order and receive the materials. It refers to the time required to
obtain new materials. It is the time gap between placing an order and
actual receipt of the materials

• Normal consumption means average consumption of material

• Normal reorder period or average reorder period is the average of
minimum and maximum reorder period
Source: ICAI
Problem 2
Z Ltd. Provides the following information in respect of Material R.
• Supply period = 5 to 15 days
• Rate of consumption
• Average = 15 units per day
• Maximum = 20 units per day
• Yearly = 5000 units
• Ordering costs = Rs. 20 per order
• Purchase price of material = Rs. 50 per unit
• Storage costs are 10% of unit value
• Compute
• Re-order Level
• Maximum Level
• Minimum Level
• Average Level
Answer 2
2𝐴𝑂 2∗5000∗20
• Re-order Quantity or EOQ = = = 40000 =
𝐶 5
200 𝑢𝑛𝑖𝑡𝑠
• A = 5000 units; O = Rs. 20 per order; C = 50 x 10% = Rs. 5
• Re-order Level = Maximum Consumption x Maximum re-order period
= 20 * 15 = 300 units
• Maximum Level = Re-order Level + Re-order quantity – (Minimum
consumption * Minimum re-order period) = 300 + 200 – (10 * 5) =
450 units
• Minimum Level = Re-order Level – (Normal consumption * Normal re-
order period) = 300 – (15 * 10) = 150 units
• Average Level = (Minimum Level + Maximum Level)/2 = (150 + 450)/2
= 300 units
Problem 3
Medical Aids Co. manufactures a special product. The following
particulars were collected for the year 2023.
• Cost of placing an order Rs. 100
• Annual carrying cost per unit Rs. 15
• Normal Usage 50 units per week
• Minimum Usage 25 units per week
• Maximum Usage 75 units per week
• Re-order period 4 to 6 weeks
• Compute
Re-order quantity; Re-order Level; Minimum Level; Maximum Level; Average
Level
Answer 3
2𝐴𝑂 2∗2600∗100
• Re-order Quantity or EOQ = = = 40000 =
𝐶 15
186 𝑢𝑛𝑖𝑡𝑠 (𝐴𝑝𝑝𝑟𝑜𝑥. )
• A = 50 * 52 = 2600 units; O = Rs. 100 per order; C = Rs. 15 p.u
• Re-order Level = Maximum Consumption x Maximum re-order period
= 75 * 6 = 450 units
• Maximum Level = Re-order Level + Re-order quantity – (Minimum
consumption * Minimum re-order period) = 450 + 186 – (25 * 4) =
536 units
• Minimum Level = Re-order Level – (Normal consumption * Normal re-
order period) = 450 – (50 * 5) = 200 units
• Average Level = (Minimum Level + Maximum Level)/2 = (200 + 536)/2
= 368 units
 Methods of Material Issue - FIFO
• First in First Out
• A method of pricing the issue of materials, in the order in which they
are purchased
• This method is considered suitable in times of falling prices because
the material cost charged to production will be high while the
replacement cost of materials will be low.
Source: ICAI
 Methods of Material Issue – Weighted
Average Method
• This method gives due weightage to quantities along with the prices
at which they bought.
• Under this method, issue price is calculated by dividing sum of
products of price and quantity by total number of quantities

Source: ICAI
 Proforma
Date Particulars Receipts Issue Balance

Units Rate Cost Units Rate Cost Units Rate Cost

(Qty) (Qty) (Qty)

Value of Closing Stock