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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
VU
LESSON# 8
CONTROL OVER MATERIAL
Control over material is essential for different reasons By and large, materials are the equivalent of
cash and therefore pilfering and theft may occur quite often if effective control is not exercised.
Prevention of material from deterioration and waste is also necessary. It is also important to
eliminate obsolete stocks with the consequence easing of storage space and storage costs-
Moreover, control over materials is necessary to prevent extra expenditure on excessive purchase
of materials and improper use of material. And above all, regular supply of materials to the
production departments would help production on schedule. It will also ensure preparation of
accurate statements of the value of material consumed by each department/job and final
statements prepared according to their needs.
From the accounting point of view, the following are some important requirements of the effective
material control;
1. That no material is purchased without proper authority.
2. That the quantity of material purchased is in fact received.
3. That there are proper storage facilities.
4. That no material is issued without proper authorization and the purpose for which the
material is required is recorded.
5. That the accounts provide a running balance of the value of the materials on hand.
Replenishment of Stock
Materials are received and issued by the storekeeper to different production departments. One
important duty of a storekeeper is the restocking of stores in order to ensure efficient functioning
of the stores department and steady flow of materials to the production departments. The inflow
and outflow of materials has to be regulated in such a manner that neither production is adversely
effected due to want of materials nor there unnecessary blocking of capital funds due to
overstocking of raw materials.
This implies that there is always a limit to the minimum and maximum quantity of materials or
stock in the store. The storekeeper is to requisition for stock for replenishment in time so as to
ensure honoring of requisition slips from production departments. Replenishment of stock
therefore implies as `taking steps for the fresh purchase of those stocks which have been exhausted
and for which requisitions are to be honored in future'.
In order to ensure that the optimum quantity of materials is purchased and stock--neither less nor
more, the storekeeper applies scientific techniques of materials management. Fixing of certain
levels for each item of materials is one of such techniques.
The following levels are generally fixed.
1. Order level.
2. Maximum level.
3. Minimum level.
4. Danger level.
Order Level
It is also known as Re-ordering level in relation with an item of stock. It is the point at which it
becomes essential to initiate purchase orders for its fresh supplies.
Normally, re-ordering level is a point between the maximum and the minimum stock levels. Fresh
orders must be placed before the actual stocks touch the minimum level, so as to take care of lapse
in time the placing of the order and the receipt of materials in stores.
Following are the factors that are taken into account for fixing re-order level.
1. The maximum consumption.
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Cost & Management Accounting (MGT-402)
VU
This is the maximum quantity of the material that is
expected to be consumed in a day or in a week or in a
month time.
2. Lead time.
This is the estimated time period in number of days or in
weeks or in months, which is necessarily required for
placing an order and finally receiving it in the stores.
There might be different lead times for different
consumptions. For example; more time will be required for
maximum consumption comparing with the time required
for minimum or average consumption.
3. Economic order quantity.
Details of the economic order quantity will be covered in
the next lesson; here this will be sufficient to learn that it is
the level where the ordering quantity will be most
economical.
Although EOQ is not required while calculating the
order/re-order level but one must keep in mind the EOQ
of the item for determining the order level.
Most of the times where purchases are made according to
the EOQ, the order level is half or the EOQ.
Formula
Order Level = Maximum Consumption x Lead Time (maximum)
Maximum Stock Level
The maximum stock level indicates the maximum quantity of an item of material which can be
held in stock at any time. The maximum stock level is fixed by taking into consideration the
following factors:--
1. Minimum rates of consumption.
This is the minimum quantity of the material that is
expected to be consumed in a day or in a week or in a
month time.
2. The lead time.
This is the estimated time period in number of days or in
weeks or in months, which is necessarily required for
placing an order and finally receiving it in the stores.
There might be different lead times for different
consumptions. For example; more time will be required for
maximum consumption comparing with the time required
for minimum or average consumption.
3. Economic ordering quantity.
Details of the economic order quantity will be covered in
the next lesson; here this will be sufficient to learn that it is
the level where the ordering quantity will be most
economical.
4. Availability of funds,
5. Availability of storage space.
6. Risk of obsolescence, depletion, evaporation and material waste,
7. Future fluctuations of price of materials.
8. Cost of storage and insurance.
9. The nature of material--seasonal supplies etc.
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Cost & Management Accounting (MGT-402)
VU
10. Any restrictions imposed by the government or restrictions in respect of import of
materials.
The maximum stock can be calculated by applying the following formula.
Formula
Reorder level ­ (Minimum consumption x Lead time) + EOQ
Putting the formula elements of reorder level over here the result will be like this:
(Maximum consumption x Lead time) ­ (Minimum consumption x Lead time) + EOQ
[(Maximum consumption - Minimum consumption) Lead time]+ EOQ
Minimum Level;
This represents the quantity below which the stock of any item should not be allowed to fall. In
other words, an enterprise must maintain minimum quantity of stock so that the production is not
adversely affected due to non-availability of materials.
The minimum stock level is fixed by taking into account:
1. Re-order level.
2. Lead time.
This is the estimated time period in number of days or in weeks
or in months, which is necessarily required for placing an order
and finally receiving it in the stores.
There might be different lead times for different consumptions.
For example; more time will be required for maximum
consumption comparing with the time required for minimum
or average consumption.
3. Average rate of consumption.
This is the minimum quantity of the material that is expected to
be consumed in a day or in a week or in a month time.
Formula
Reorder level-- (Average consumption x lead time)
Putting the formula elements of reorder level over here the result will be like this:
(Maximum Consumption ­ Average Consumption) x Lead time
Danger Level
The danger level is below the minimum level and represents a stage where immediate steps are
taken for getting stock replenished. When the stock reaches danger level it is indicative that if no
emergency steps are taken to restock the materials, the stores will be completely exhausted and
normal production stopped. Generally, the danger level of stock is fixed above the minimum level.
The danger stock level is fixed by taking into account:
1. Average Consumption.
2. Emergency Lead Time.
Formula
Average consumption x Emergency time
PRACTICE QUESTIONS
Q. 1
Following is the information provided by the concerned departments about two components
FRAME and VASE regarding their replenishment and usage:
Minimum usage
25 units per week each
Maximum usage
75 units per week each
Average usage
50 units per week each
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Cost & Management Accounting (MGT-402)
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Re-order quantity
Frame
300 units
Vase
500 units
Re-order period
Frame
4 to 6 weeks
Vase
2 to 4 weeks
Emergency lead time
Frame
2 weeks
Vase
1 week
Calculate for each component:
1.
Re-order level,
2.
Maximum stock level, and
3.
Minimum stock level,
4.
Danger stock level.
Solution
Re-order level:
Maximum consumption x Lead Time [maximum]
Frame
75x6
450 units
Vase
75x4
300 units
Maximum stock level:
Reorder level ­ (Minimum consumption x Lead time [minimum]) + EOQ
Frame
450 + 300 ­ (25 X4)
650 units
Vase
300 + 500 ­ (25x2)
750 units
Minimum stock level:
Reorder level ­ (Average consumption x lead time [Average])
Average lead time = Maximum + Minimum
2
Frame
450 ­ (50X5)
200 units
Vase
300 ­ (50X3)
150 units
Danger stock level:
Average consumption x Emergency lead time
Frame
50 x 2
100 units
Vase
50 x 1
50 units
Q. 2
From the following information calculate the Maximum stock level, Minimum stock level,
Re-ordering level and Danger stock level;-
(a) Average consumption
330 units per day
(b) Maximum consumption
420 units per day
(c) Minimum consumption
240 units per day
(d) Re-order quantity
3,600 units
(e) Re-order period
10 to 15 days
(f) Emergency Re-order period  12 days
Solution :
Re-ordering level:
Maximum consumption x Lead Time [maximum]
420x15
6,300 units.
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Cost & Management Accounting (MGT-402)
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Maximum stock level:
Reorder level ­ (Minimum consumption x Lead time [minimum]) + EOQ
6,300 ­ (240 x 10) + 3,600
7,500 units
Minimum stock level:
Reorder level ­ (Average consumption x lead time [Average])
Average lead time
= Maximum + Minimum =15+10 =12.5
2
2
6,300 - 330 x 12.5
2,175 units
Danger stock level:
Average consumption x Emergency lead time
330 x 12
3,960 units
PROBLEMS
Q. 1
From the following particulars, calculate: --
Re-order level, Minimum level, Maximum level, and Danger level.
Average usage
400 units per day
Minimum usage
60 units per day
Maximum usage
130 units per day
Economic order quantity
5000 units
Re-order period
25 to 30 days
Q. 2
In manufacturing its Products, a Company uses three raw materials. A, B and C, in respect of
which the following apply:
Raw
Usage per unit of
Re-order
Price
Delivery Period
Re-order
material
Product
Quantity
Per kg.
level kg,
kg.
kg.
Min
Avg
Max
A
10
10,000
0.10
1
2
3
8,000
B
4
5,000
0.30
3
4
5
4,750
C
6
10,000
0.15
2
3
4
2,000
Weekly production varies from 175 to 225 units, averaging 200 units.
What would you expect the quantities of the following to be:
(a) Minimum stock of A
(b) Maximum stock of B
(c) Re-order level of C
(d) Danger stock level of A
Q. 3
Two components of A and B are used as follows:--
Normal usage
50 units per week each
Minimum usage
25 units per week each
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Cost & Management Accounting (MGT-402)
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Maximum usage
75 units per week each
Re-order quantity--A : 400 units ; B : 600 units.
Re-order period-- A : 4 to 6 weeks : B : 2 to 4 weeks.
Calculate for each component;
(a) Re-order level
(b) Minimum level
(c) Maximum level
(d) Danger stock level.
Q. 4
What do you understand by maximum stock level, minimum stock level, and reorder level?
Calculate the above from the following data:
Re-order quantity
1,500 units
Re-order period
4 to 6 weeks
Maximum consumption 400 units per week
Average consumption
30 units per week
Minimum consumption 250 units per week
Q. 5
The following information is available in respect of component FS-6:
Maximum stock level
8,400 units
Budgeted consumptions:
Maximum
1,500 units per month
Minimum
800 units per month
Estimated delivery period
Maximum
4 months
Minimum
2 months
You are required to calculate:
(i) Re-order level
(ii) Economic Order Quantity
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Table of Contents:
  1. COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION,
  2. IMPORTANT TERMINOLOGIES:Cost Center, Profit Centre, Differential Cost or Incremental cost
  3. FINANCIAL STATEMENTS:Inventory, Direct Material Consumed, Total Factory Cost
  4. FINANCIAL STATEMENTS:Adjustment in the Entire Production, Adjustment in the Income Statement
  5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS:Gross Profit Margin Rate, Net Profit Ratio
  6. MORE ABOUT PREPARATION OF FINANCIAL STATEMENTS:Conversion Cost
  7. MATERIAL:Inventory, Perpetual Inventory System, Weighted Average Method (W.Avg)
  8. CONTROL OVER MATERIAL:Order Level, Maximum Stock Level, Danger Level
  9. ECONOMIC ORDERING QUANTITY:EOQ Graph, PROBLEMS
  10. ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio
  11. LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES
  12. PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans
  13. PIECE RATE BASE PREMIUM PLANS:Suitability of Piece Rate System, GROUP BONUS SYSTEMS
  14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY OVERHEAD COST
  15. ALLOCATION AND APPORTIONMENT OF FOH COST
  16. FACTORY OVERHEAD COST:Marketing, Research and development
  17. FACTORY OVERHEAD COST:Spending Variance, Capacity/Volume Variance
  18. JOB ORDER COSTING SYSTEM:Direct Materials, Direct Labor, Factory Overhead
  19. PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output
  20. PROCESS COSTING SYSTEM:Cost of Production Report, Quantity Schedule
  21. PROCESS COSTING SYSTEM:Normal Loss at the End of Process
  22. PROCESS COSTING SYSTEM:PRACTICE QUESTION
  23. PROCESS COSTING SYSTEM:Partially-processed units, Equivalent units
  24. PROCESS COSTING SYSTEM:Weighted average method, Cost of Production Report
  25. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Accounting for joint products
  26. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Problems of common costs
  27. MARGINAL AND ABSORPTION COSTING:Contribution Margin, Marginal cost per unit
  28. MARGINAL AND ABSORPTION COSTING:Contribution and profit
  29. COST VOLUME PROFIT ANALYSIS:Contribution Margin Approach & CVP Analysis
  30. COST VOLUME PROFIT ANALYSIS:Target Contribution Margin
  31. BREAK EVEN ANALYSIS MARGIN OF SAFETY:Margin of Safety (MOS), Using Budget profit
  32. BREAKEVEN ANALYSIS CHARTS AND GRAPHS:Usefulness of charts
  33. WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets
  34. Production & Sales Budget:Rolling budget, Sales budget
  35. Production & Sales Budget:Illustration 1, Production budget
  36. FLEXIBLE BUDGET:Capacity and volume, Theoretical Capacity
  37. FLEXIBLE BUDGET:ANALYSIS OF COST BEHAVIOR, Fixed Expenses
  38. TYPES OF BUDGET:Format of Cash Budget,
  39. Complex Cash Budget & Flexible Budget:Comparing actual with original budget
  40. FLEXIBLE & ZERO BASE BUDGETING:Efficiency Ratio, Performance budgeting
  41. DECISION MAKING IN MANAGEMENT ACCOUNTING:Spare capacity costs, Sunk cost
  42. DECISION MAKING:Size of fund, Income statement
  43. DECISION MAKING:Avoidable Costs, Non-Relevant Variable Costs, Absorbed Overhead
  44. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
  45. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS:MAKE OR BUY DECISIONS