Materials & material control accounting

Number of orders = 6 orders

$\text{Number of orders} = \frac{\text{Annual requirement}}{\text{EOQ}} = \frac{18{,}000}{3{,}000} = 6$

20 orders

Number of orders = Annual requirement ÷ EOQ = 600,000 ÷ 30,000 = 20 orders

A centralized store is a single central store that receives all materials for the whole organisation and issues them to all departments or branches as needed. It keeps stock at one place, which makes control, recording and supervision of materials easier and avoids duplication of store records.

Indirect materials are those materials which cannot be identified with or directly charged to a specific product, job, or cost unit — they are used to support the production process as a whole rather than to make up the finished product itself. Their cost is therefore treated as part of factory overhead and not as direct material cost. Examples: lubricating oil, cleaning rags, glue, nails, and small consumable tools.

A bin card is a quantitative record maintained in the store for each item of material, showing the quantity of materials received, issued, and the balance in hand.

EOQ = 1,000 units

$\text{EOQ} = \sqrt{\frac{2AO}{C}}$

where $A = 2{,}00{,}000$ units, $O =$ Rs 100 per order and $C =$ Rs 40 per unit.

$\text{EOQ} = \sqrt{\frac{2 \times 2{,}00{,}000 \times 100}{40}} = \sqrt{10{,}00{,}000} = 1{,}000 \text{ units}$

Centralized purchase: Centralized purchase is a system in which all purchases of goods for the whole organisation are made by a single central department (usually the head office or a central purchase department) for all branches, departments or units. It brings uniformity in buying, bulk discounts and better control, but it is slow and less flexible.

Decentralized purchase: Decentralized purchase is a system in which each branch, department or unit makes its own purchases independently according to its local needs. It is quick and flexible and suits local requirements, but it loses the benefit of bulk buying and makes control difficult.

Given:

• Opening stock: 1,000 units @ Rs. 10
• Purchases: 700 units @ Rs. 12 and 900 units @ Rs. 15
• Sales: 1,800 units

Total units available for sale = 1,000 + 700 + 900 = 2,600 units
Closing stock = 2,600 − 1,800 = 800 units

Under the periodic LIFO method, sales are assumed to be made from the most recent purchases first.

Calculation of Cost of Goods Sold (COGS):

Calculation of Closing Stock:

Remaining units from opening stock = 1,000 − 200 = 800 units

Answer:

• Cost of Goods Sold = Rs. 23,900
• Closing Stock = Rs. 8,000

A decentralized store is a system of storekeeping in which separate stores are maintained for each department or production unit, and each such store independently receives, stores, and issues materials, maintaining its own records of materials received and issued.

Advantages of Centralized Purchase

Centralized purchase means all purchases of materials for the whole organisation are made by a single central purchasing department instead of by each branch, factory or department separately. Its advantages include the following.

1. Economy in purchasing (lower cost of materials). Since the central department buys in large quantities, it can obtain trade discounts, quantity discounts and better credit terms. It also avoids duplication of purchasing effort and staff in every department. As a result the cost per unit of materials falls, which directly reduces the cost of production and increases profit. For example, if a company needs 10,000 units of a raw material and buys them together, it may get a 10% discount that no single department could have got by buying 1,000 units on its own.

2. Better control and uniformity of quality. A single department can fix standard specifications for each item and buy only from approved suppliers, so materials of uniform quality reach every department. This reduces the risk of inferior or sub-standard materials, avoids disputes with suppliers, and makes it easier to check purchase prices, quantities and stock levels against budgets. Specialised and expert purchasing staff can also be employed, since the volume of work justifies it, leading to more efficient buying decisions.

Other advantages, such as avoidance of over-stocking, prompt delivery and easier negotiation with suppliers, follow from the same centralised arrangement.

Closing stock = Rs 9,200 and cost of goods sold = Rs 32,400 (FIFO, periodic)

Closing stock = 1,900 − 1,500 = 400 units.

Under FIFO the oldest units are sold first, so the closing stock comes from the latest purchase:

• Closing stock = 400 units × Rs 23 = Rs 9,200

Cost of goods sold = 500 × 20 + 600 × 22 + 400 × 23 = 10,000 + 13,200 + 9,200 = Rs 32,400

Check: 32,400 + 9,200 = 41,600.

Direct material cost is the cost of raw materials that can be directly identified with and charged to a particular product or job.

EOQ = 800 units

$\text{EOQ} = \sqrt{\frac{2AO}{C}} = \sqrt{\frac{2 \times 80{,}000 \times 40}{10}} = \sqrt{6{,}40{,}000} = 800 \text{ units}$

Meaning of Materials Control

Materials control is the process of planning, purchasing, storing, issuing and accounting for materials (raw materials, components and supplies) in such a way that the right quantity and quality of materials is available at the right time and at the right cost, without holding excessive stock.

In simple words, it means regulating the flow of materials into, through and out of the organisation so that production is never interrupted by shortage, and money is never blocked in unnecessary or wasteful stock. It covers purchase control, store (inventory) control, issue control and stock-level control.

Cost of goods sold = Rs 8,200 and ending inventory = Rs 1,400 (FIFO, periodic)

Ending inventory = 800 − 700 = 100 units, valued at the latest price: 100 × Rs 14 = Rs 1,400.

Cost of goods sold = 200 × 10 + 400 × 12 + 100 × 14 = 2,000 + 4,800 + 1,400 = Rs 8,200

Check: 8,200 + 1,400 = 9,600.

Material codification means assigning a unique code or number to each item of material (raw material, components, stores, etc.) so that it can be identified easily and quickly.

Under this system, every material is given a distinct symbol or number, and a code book or catalogue is maintained listing all materials with their codes. It helps in avoiding duplication of names, ensures accurate and speedy recording of stores transactions, and makes computerised accounting and stock control simple and reliable.

Closing stock = Rs 5,500 and cost of goods sold = Rs 12,200 (FIFO, periodic)

Closing stock is 550 units (physical count). Under FIFO it is valued at the latest price, and 550 is less than the 800 units of the last purchase:

• Closing stock = 550 × Rs 10 = Rs 5,500
• Cost of goods sold = 17,700 − 5,500 = Rs 12,200

Check (1,400 units sold): 650 × 8 + 500 × 9 + 250 × 10 = 5,200 + 4,500 + 2,500 = 12,200.

Material control means the systematic planning, purchasing, storing, issuing and accounting of materials (raw materials and components) so that the right quantity and quality of material is available at the right time and place, at minimum cost, without overstocking or shortage.

Two advantages of centralized purchasing:

1. Economies of scale (lower cost): Purchasing in large quantities for the whole organization earns trade discounts, quantity discounts and better credit terms, which reduces the cost of materials per unit.

2. Better control and uniformity: All purchases are made by one department following a uniform procedure, so quality standards are maintained and duplication of effort, over-purchasing and misuse of funds are easily checked.

Cost of goods sold = Rs 5,800 and closing inventory = Rs 1,500 (LIFO, periodic)

Closing inventory = 1,200 − 900 = 300 units. Under LIFO the latest units are sold first, so the closing inventory consists of the oldest units:

• Closing inventory = 300 × Rs 5 = Rs 1,500
• Cost of goods sold = 400 × 7 + 500 × 6 = 2,800 + 3,000 = Rs 5,800

Check: 5,800 + 1,500 = 7,300.

Codification of materials is the process of assigning a unique code (numeric, alphabetic or alphanumeric) to each item of material so that it can be easily identified, stored, issued and recorded.

For example, material "Steel Plate 5 mm" may be coded as SP-05. It helps in avoiding duplication of names, ensures quick identification in stores records, and simplifies accounting and computerised inventory control.

Number of orders = 25 orders

Working:

$\text{Number of orders} = \frac{\text{Annual material requirement}}{\text{Economic order quantity}} = \frac{50,000}{2,000} = 25 \text{ orders}$

Advantages of Decentralized Purchase

Decentralized purchasing means each department, branch or unit of an organisation makes its own purchases instead of buying through one central purchase department. Its main advantages are:

1. Quick and timely purchase – Each department buys its requirements as soon as the need arises, so there is no delay waiting for approval from a central office. This keeps work running smoothly.

2. Better knowledge of local needs – The departmental head knows the exact quality, quantity and specification of materials required, so purchases suit actual needs and wastage is reduced.

3. Benefit of local market and low transport cost – Purchases are made from nearby suppliers, which saves transport, packing and handling costs and gives quick delivery.

4. Prompt after-sales service – Since suppliers are local, repairs, replacements and service can be obtained quickly and easily.

5. Reduced burden on top management – Departmental heads handle their own buying, so the central office is free to concentrate on policy and planning matters.

6. Healthy competition and initiative – Departments compete with one another to buy better and cheaper, which develops the initiative and responsibility of departmental managers.

7. Easy comparison of performance – The cost and efficiency of each department can be compared, which helps in measuring the performance of each unit.

8. Flexibility – The system can be adjusted easily to changing needs, prices and market conditions of each locality.

Ending inventory = Rs 6,015.63 and cost of goods sold = Rs 11,484.37 (weighted average, periodic)

$\text{Weighted average cost per unit} = \frac{17{,}500}{1{,}600} = \text{Rs }10.9375$

Ending inventory = 1,600 − 1,050 = 550 units

$\text{Ending inventory} = 550 \times 10.9375 \approx \text{Rs }6{,}015.63$

$\text{Cost of goods sold} = 17{,}500 - 6{,}015.63 = \text{Rs }11{,}484.37$

(Equivalently, 1,050 × 10.9375 ≈ Rs 11,484.)

A purchase order is a written order sent by the purchase department to a supplier, asking it to supply stated materials of a given quantity and quality at an agreed price and on agreed terms of delivery and payment. Once the supplier accepts it, it becomes a legal contract.

Where the annual consumption and the number of orders are known, the order size is

$\text{EOQ} = \frac{\text{Annual consumption}}{\text{Number of orders}} = \frac{7{,}000}{5} = 1{,}400 \text{ units}$

Under the periodic system the average cost is found once, at the end of the period, using all units available for sale.

$\text{Weighted average cost} = \frac{15{,}60{,}000}{13{,}000} = \text{Rs } 120 \text{ per unit}$

• Cost of goods sold = $10{,}000 \times 120 =$ Rs 12,00,000
• Closing stock = $(13{,}000 - 10{,}000) \times 120 = 3{,}000 \times 120 =$ Rs 3,60,000

Check: Rs 12,00,000 + Rs 3,60,000 = Rs 15,60,000.

Given: Annual requirement (A) = 30,000 units Ordering cost per order (O) = Rs 300 Carrying cost per unit (C) = Rs 2

Formula: $EOQ=\sqrt{\frac{2AO}{C}}$

Substitution: $EOQ=\sqrt{\frac{2 \times 30{,}000 \times 300}{2}}$ $EOQ=\sqrt{9{,}000{,}000}$ $EOQ=3{,}000 \text{ units}$

Economic Order Quantity = 3,000 units

Periodic inventory system is a system of recording inventory in which the stock position is not updated after every purchase or sale; instead, the cost of goods sold and closing inventory are determined only at the end of the accounting period by physically counting the stock.

Material classification means dividing the materials used by an organisation into different groups or categories on the basis of their nature, use and value, so that they can be stored, issued and controlled properly.

On the basis of value and use, materials are mainly classified as:

• Direct materials — materials that become part of the finished product and can be traced to it, e.g. raw cotton in a cotton mill, timber in a furniture factory.
• Indirect materials — materials used in the production process but not traceable to a specific product, e.g. lubricants, cleaning materials, small tools.

Other bases of classification are raw materials (cotton, timber), work-in-progress (partly finished goods), finished components (bolts, nuts) and consumable stores (stationery, fuel).

FIFO Method — Periodic Inventory System

Working: Units

Cost of Ending Inventory (FIFO — latest purchases remain)

Cost of Goods Sold (FIFO — earliest purchases issued first)

Answer:

• Cost of ending inventory = Rs. 10,500
• Cost of goods sold = Rs. 22,000

(Check: Rs. 3,000 + Rs. 10,000 + Rs. 9,000 = Rs. 22,000; and Rs. 22,000 + Rs. 10,500 = Rs. 32,500 = total cost of goods available for sale.)

Note: Under FIFO, the 850 units sold are taken from the oldest layers first — 150 units @ Rs. 20 = Rs. 3,000, then 400 units @ Rs. 25 = Rs. 10,000, and then 300 units @ Rs. 30 = Rs. 9,000. The ending inventory of 350 units consists of the most recent purchase @ Rs. 30.