Chapter-5: Cost of Materials
A: Storing of Materials
Effective storage of materials is essential for
smooth business operations. Proper storage helps prevent losses, damage, and
pilferage, ensuring that materials are available when needed.
i) Bin
Card – Definition and Necessity
Definition: A Bin Card is a physical or
electronic record maintained for each item in a store. It tracks the receipt,
issue, and balance of materials.
Necessity:
Helps in
monitoring stock levels.
Provides
uptodate information on the quantity of materials.
Assists
in preventing stockouts and overstocking.
Useful
for verifying physical stock with book records.
ii)
Stores Ledger – Definition and Necessity
Definition: A Stores Ledger is a detailed record
maintained in the accounts department that keeps a record of all transactions
related to materials, including receipts, issues, and balances.
Necessity:
Provides
a comprehensive record of material movements.
Helps in
cost control and planning.
Facilitates auditing and reconciliation with
physical stock.
Useful
for financial reporting and decisionmaking.
iii)
Centralized Stores and Decentralized Stores
Centralized Stores:
All
materials are stored in a single location.
Advantages: Better control, reduced
duplication, and lower storage costs.
Disadvantages: Higher transportation costs,
longer lead times.
Decentralized Stores:
Materials
are stored in multiple locations close to the point of use.
Advantages: Reduced transportation costs,
quicker access to materials.
Disadvantages: Higher storage costs, risk of
duplication.
B:
Materials Control
Effective materials control ensures the right
quantity of materials is available at the right time, minimizing costs and
maximizing efficiency.
i)
Necessity of Material Control
Prevents
overstocking and stockouts.
Reduces
storage costs and wastage.
Ensures
smooth production operations.
Improves
financial management and profitability.
ii) Fixation
of Stock Levels of Materials
To ensure effective materials control, it is
essential to fix various stock levels:
1. Reorder Stock Level: The level at which new
orders should be placed to replenish stock.
Formula: Reorder Level = Maximum Consumption ×
Maximum Reorder Period
Example: If maximum consumption is 200 units
per day and the maximum reorder period is 10 days, then Reorder Level = 200 ×
10 = 2000 units.
2. Maximum Stock Level: The maximum quantity of
materials to be kept in stock to avoid overstocking.
Formula: Maximum Level = Reorder Level + Reorder
Quantity (Minimum Consumption × Minimum
Reorder Period)
Example: If the reorder level is 2000 units,
reorder quantity is 5000 units, minimum consumption is 100 units per day, and
minimum reorder period is 5 days, then Maximum Level = 2000 + 5000 (100 × 5) = 2000 + 5000 500 = 6500 units.
3. Minimum Stock Level: The minimum quantity of
materials to be kept in stock to avoid stockouts.
Formula: Minimum Level = Reorder Level (Average Consumption × Average Reorder Period)
Example: If the reorder level is 2000 units,
average consumption is 150 units per day, and average reorder period is 7 days,
then Minimum Level = 2000 (150 × 7) =
2000 1050 = 950 units.
4. Average Stock Level: The average quantity of
materials in stock.
Formula: Average Level = (Maximum Level +
Minimum Level) / 2
Example: If the maximum level is 6500 units
and the minimum level is 950 units, then Average Level = (6500 + 950) / 2 =
7450 / 2 = 3725 units.
5. Danger Stock Level: The level at which
immediate action is required to replenish stock to avoid production stoppages.
Formula: Danger Level = Average Consumption ×
Lead Time for Emergency Purchases
Example: If the average consumption is 150
units per day and lead time for emergency purchases is 2 days, then Danger
Level = 150 × 2 = 300 units.
iii)
Fixation of Economic Order Quantity (EOQ)
Definition: EOQ is the order quantity that
minimizes the total holding costs and ordering costs.
Advantages of EOQ:
Reduces
total inventory costs.
Helps in
maintaining an optimal inventory level.
Improves
cash flow and liquidity.
C: Methods of Pricing Materials
Pricing materials issued from stores involves
determining the cost at which materials are issued for production or sale.
Methods
of Pricing Materials Issued from Stores
1. FIFO Method (FirstIn, FirstOut):
Materials purchased first are issued first.
Advantages: Simple, follows actual material
flow.
Limitations: Not suitable during inflation as
it may undervalue stock.
2. LIFO Method (LastIn, FirstOut):
Materials purchased last are issued first.
Advantages: Matches current costs with current
revenues.
Limitations: Can lead to older stock remaining
unsold.
3. Simple Average Method:
Issues are priced at the average cost of all
units.
Advantages: Easy to calculate.
Limitations: May not reflect actual cost
accurately.
4. Weighted Average Method:
Issues are priced at the weighted average cost
of all units.
Advantages: Smoothens price fluctuations.
Limitations: Slightly more complex to
calculate.
Preparation of Stores Ledger Accounts
Stores Ledger Accounts track the quantity and
cost of materials received, issued, and remaining in stock.
Example Using FIFO Method:
Opening
stock: 100 units @ ₹10 each.
Purchase:
200 units @ ₹12 each.
Issue:
150 units.
Calculation:
1. Issue 100 units from opening stock @ ₹10 each = ₹1000.
2. Issue 50 units from purchase @ ₹12 each = ₹600.
3. Total cost of issue = ₹1000 + ₹600 = ₹1600.
4. Remaining stock = 150 units @ ₹12 each.
References
1. Horngren, C.T., Datar, S.M., & Rajan,
M.V. (2018). Cost Accounting: A Managerial Emphasis. Pearson.
2. Bhattacharyya, A. (2020). Cost Accounting for
CA IPCC. Pearson Education India.
3. Maheshwari, S.N., & Mittal, S.N. (2021). Cost
Accounting: Theory and Problems. Mahavir Publications.
4. Official website of the Institute of Cost Accountants of India (icmai.in).
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