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BBA CA Lecturenotes-56-110

Cost Accounting (Babu Banarasi Das University)

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type of materials inthe right quality and quantity is purchased from a right source at the right
price and time.

Whether an organization opts for centralized purchasing or decentralized purchasing depends on

a number of factors such as size of the organization, Percentage of materials in the total cost and
nature of materials. In case of centralized purchasing there is one central purchase department
which makes purchases of all types of materials for all departments in the organization. The
central purchase department can be located at one place or it may have its sub units located at
different places.All departments which require any type of material supplies, services, tools,
components etc. send their requirements in the form of indents or purchase requisitions to the
centralized purchasing department which makes the purchases as per specifications, specific
procedures and norms.

In case of decentralized purchasing each branch or department does its own purchasing. In this
case theadvantages of centralized purchasing like bulk discounts, specialized knowledge, less
purchasing overhead cost per unit, expert quality testing is not available. But on the other hand,
when branches and departments are located far and wide, it may not be practical to do
centralized purchasing and hence decentralized purchasing is done. More so in case of urgent
needs, small purchases, highly technical material requiring testing by the user department,
decentralized purchasing is suitable.

In most of the cases, a blend of centralized and decentralized purchasing is adopted. Material of
standard specifications and required in bulk are reserved for centralized purchasing while highly
technical materials, small value materials or materials available cheaper in local markets are
allowed to be purchased by the user department.

Just in Time Purchasing (JIT):

This concept aims at eliminating avoidable investment in stocks of raw materials, work in
progress and finished goods. Raw material is procured just when they are required for production
and production is fully synchronized with sale. This leads to minimization of loses due to
pilferage, spoilage and obsolescence. This needs a close relationship with suppliers and frequent
deliveries of small quantities so that deliveries just precede their use. The guaranteed quality of
materials is directly delivered to the shop floor just when needed.

Purchase Procedure:

The initiation of purchase begins with the receipt of purchase requirement/ requisition slip by the
purchase department from either the stores department for regular stocks items or by the
departmental head for specialized materials. The purchase requisition is the formal request made
by the stores or the user department to the purchase department. This requisition contains
complete details such as the date of making the request, the quantity, quality, any specific
characteristic of material demanded, code number of material required, the latest date by which
material should be available etc.

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SPECIMEN OF PURCHASE REQUISITION OR INDENT

XYZ Ltd.
ABC Department
Purchase Requisition (Regular/Special)
Purchase Requisition No…..
Date: Date By Which Required……….

Serial No. Stores Code Description of Grade Or Quantity Remarks

No. Material Quality

Requisitioned By………..Checked By…………. Approved by………

For use in Purchase Department
Quotation invited on and from:
Date Quotation by
1. ----------
----- ------------1.
2. ----------
----- ------------2.
Purchase order No----- Date----------
---------Nameofthesupplier Promised /Expected Delivery Date-----
Remarks----------- Purchase Officer-----

The purchase requisition has to be prepared in triplicate- one copy has to be sent to the purchase
department for initiating the purchase procedure, second to the costing department and the third
copy is retained by the department initiating the purchase requisition.

Exploring the supply sources and selection of supplier:

On the receipt of purchase requirement/requisition, the purchase department would invite tenders
or quotations for the supply of goods. After the receipt of quotations, the purchase department
will make the schedule of quotations for the selection of a supplier, keeping in mind all the
required considerations such as price, quality, and terms of payment, reliability of supplier, mode
and time of delivery. The schedule may be in the following format:

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SPECIMEN FORM OF TENDER/ INVITATION OF QUOTATION

ABC Ltd.
Tender Form
Tender No.---------
Date------
Dear Sir,
Your best offer to supply the following items is solicited. The delivery should be F.O.R Delhi.
th
The tender closed on September 30 2016 and will be opened next day at 10.00 AM.
Yours Sincerely
For ABC Ltd.
Purchase Officer

Serial No Description of Quality/Grade Quantity Price Terms of Other

Materials Delivery Terms

SPECIMEN FORM OF COMPARATIVE STATEMENT OF QUOTATION

SCHEDULE OF QUOTATION
-------------Materialname Date -----------
---------------TenderNo
Name of the Rate per Time of Terms of Remarks
supplier Kg Delivery Delivery
A 1000/- 7 days Free
B 1030/- 6 days Free Accepted
C 1100/- 7days Free
D 1070/- 7days Free
-------PurchasingClerk --------------PurchaserManager

Purchase Order:

Having selected the supplier, the next step is placing a formal purchase order i.e. The written
authorization to the vendor to supply specific quantity and quality of materials at stipulated terms
and at the time and place mentioned. It is to be signed by the purchase manager. The requisition
format may be in the following format:

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ABC Co.
Ltd.
PURCHASE ORDER
To, XYZ & Co. Purchase Order No. 441
Delhi RequisitionNo. 112
nd
Date: 22 September 2016
Date: by which materials are
th
Required- 30 Sep. 2016
Please supply the following;
Serial Description of Articles Quantity Rate Amount
no

1. 6 ft log of woods 12 dozens 24,000/dozen Rs 2,88,000/-

2.
3.
4.
Please quote purchase order number on all the advice notes and invoices.
Terms of Delivery------------
Discount Allowed------------
Terms of payment: 20 days‟ credit
Packing and Dispatching Instructions- sealed cartons
R Venkateshwar
Purchase Manager
For ABC Ltd.

RECEIVING OF MATERIALS:

The work of unpacking the goods and their verification is performed by the receiving
department. The receiving clerks verify the contents of the packages with the consignment notes
sent by the suppliers in triplicate along with the packages. He enters the date of receipts, quantity
received by him and the condition of goods in the material received report. The original copy of
consignment note along with material received report in duplicate is sent to the stores
department. Five copies of Material received report are generally prepared. The original is sent to
the purchasing department as a proof that the goods ordered have been received. Three copies are
sent to the stores/ production department along with the materials. Stores /production department
sends one copy each to the receiving department and to the accounts departments. One copy is
retained for the future reference. The report may be in the following format:

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MATERIAL RECEIVED REPORT

------- G.R.N No.---
Receivedat -----PurchaseOrderNo: --
Name of the Carrier -------------------DeliveryNote/ChallanNo.Date:
---------Dateofdelivery:
From: XYZ Ltd, Mumbai.
Quantity Description Stock Condition of Amount
Received code No Goods Rs
12 dozens 6 ft log of woods RZ 20 Good 2,88,000

Inspected By-------
Received By: --------
----------- ---------
CountedBy: Approvedby:
(Receiving Officer)

INSPECTION OF MATERIALS:

The inspection department will confirm that whether the goods have been received as per the
specification mentioned in the purchase order or not. It may also send samples for laboratory
test, if necessary. It submits its reports of Inspection and testing in triplicate. The original is sent
to the purchasing department and second to the stores or production department and third is
retained by the department for future reference. The inspection report can be in the following
format:

XYZ Ltd.
Material Inspection Report
-----------
------------DateofReceipt GoodsReceivedNoteNo.
-------------- Date:-------
PurchaseOrderNo. ------
------------------ChallanNo
--------
SuppliersNameandAddress

Serial Description Code Quantity Remarks Initials of

No. No Received Rejected Accepted for Person
Rejection Inspecting

Special Remarks---------- -----------

------------ ChiefInspector

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STORAGE OF MATERIALS:

After the purchase process has been completed and materials have reached the stores it is
necessary to ensure that these are efficiently stored. The store keeper should accept the materials
only after verifying the material received with consignment note, material received report and
inspection report.

Classification and Codification:

Classification is the process of arranging items in groups and sub groups according to common
characteristics. Materials should be classified according to the nature (subjective Classification)
or the purpose to be fulfilled (objective classification). The subjective classification is useful for
identification, storage, ordering and accounting of materials. The objective classification is
useful for costing purposes.

Classification and codification go together. Classification is the first step and Codification is the
next step. Codification is the process of assigning a symbol or number to different items of
material falling in different groups and subgroups. According to ICMA terminology “a code has
been defined as a system of symbols designed to be applied to a classified set of items”.
Classification facilitates identification of items on the basis of description while coding is the
process of assigning symbol or code number on the basis of classification. Code is shorter,
precise and substitute for long and imprecise description.

The codification can be as per any of the three methods.

Alphabetical
Numerical
Alphabetical cum Numerical

Bins and Racks:

The store should be divided into several sections for particular types of material. Each section
should have various suitable containers for keeping different variety of that material. Such
containers or place are called as bins or racks. Each bin or rack is properly numbered and
indexed for easy identification. The floor plan also exhibit at the entrance of store room for ready
location of various sections and corresponding bins. The card is hung outside each bin and
whenever the material is received or issued, entry is made in the card by the store keeper and
correspondingly the balance is shown after every transaction. Thus, bin card consist of three
columns only and gives the ready reference for finding the balance of material available at any
point of time.

Stores Ledger:

The cost office maintains a store ledger in which separate card is maintained for each type of raw
material and spare parts in the store. Stores ledger gives the same information as is available in
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the bin cards except that it gives the monetary information also, such as the rate, amount of
receipts, issues and the balance of materials. So the stores ledger account has three broad
sections – receipts with quantity, rate and amount, issues with quantity, rate and amount and
balance with quantity, rate and amount. Sometimes it also consists of a fourth section-for
material ordered. This column enables the planning of production without unnecessary reference
to other books and accounts.

Distinction between Bin card and stores ledger:

Bin Card contains only quantitative record of receipt, issue and balance of different
materialswhile stores ledger records both quantities and value of materials.
Bin card is maintained by the store keeper in the stores department while the stores ledger is
maintained by the cost clerk in the costing department.
Posting in the bin card is made simultaneously with the receipt and issue of materials while the
in the stores ledger, it is made after the transaction.
Bin card is not a basic accounting record while stores ledger is a basic accounting record.
Inter department transfer or inter job transfer are only recorded in the stores ledger and not in
the bin card.

BIN CARD

Bin No Description
----Department ------MaximumQuantity
-----
StoresLedgerFolio ------MinimumQuantity
-------------
------CodeNo Reorderlevel

Receipts Issues Balance Remarks

Date Challan or Quantity Date Requisiti Quantity in Quantity in Goods on

Credit Slip in on tonnes tonnes order or
number tonnes or Number audit notes
Kgs.

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Stores Ledger
Name of the article:----Folio------Maximum Quantity------
Symbol/Code Number--- Unit---------- Minimum Quantity------
Bin Number ------- Source of Supply----- Ordering Level-----------

Ordered Reserved Received Issued Balance Stock

checked
D P Q D J Q D G Q R A D M. Q R A Q R A D Ini Re
/ O t / o t / R t at m / R. t at m t at m / tia ma
T N y T b y T R y e t. T No. y e t. y e t. T ls rks
. n . N . . .
o o.
.

PON – Purchase Order Number

GRRNo --- Goods Requisition Receipt Note Number
M.R. No. – Material Requisition No.
D/T – Date
Amt. - Amount
Qty. - Quantity

Investment in Materials:

One of the basic objectives of Material Control is to make the best use of every Rupee invested
in inventories. This requires that the right quantity of material should be ordered at the right level
of stock so that the production and sales process goes on smoothly. This avoids excess
investment in materials, maintain necessary cushions in the forms of safety stocks which act as a
buffer against contingencies, ensure availability of all material items just in time and control
scraps, wastages, spoilage and defectives. There should be neither overstocking nor under
stocking. This leads to minimization of material holding related cost.

Safety Stock:

Safety stock serves the same purpose in a business unit as a shock absorber in a vehicle. It
maintains a cushion for contingencies arising out of uncertainties on either demand/supply side.
Higher the degree of uncertainties, greater is the need for safety stock. Each producer has to
exercise the balance between the cost of having plenty of safety stocks and the risk of lack of
safety stocks. The objective should be to optimize the total cost/risk entailed in fixing the level of
safety stock.
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Economic Order Quantity (EOQ):

It refers to the size of the purchase order for a material which results in making material
available in a year at minimum total material related costs. Cost relating to materials is:-
Purchase Cost
Ordering Cost
Storage Cost
Stock Out Cost

The order size which results in lowest material related costs for meeting a given material
requirement in a period is EOQ. Thus, if EOQ is adopted as ordering quantity or the re-order
quantity than the sum total of prices paid for materials, ordering cost and storage costs will be
least. In case the prices of the materials do not change with change in order size than EOQ is
determined by only ordering cost and storage costs.

Purchase cost:
The cost of acquiring the raw material from the supplier is called as Purchase Cost.

Ordering Cost:
All costs involved in placing the orderis considered as Ordering Cost. Example: transportation
cost, travelling allowances of purchases officers, telephone bills, printing and stationery bills etc.
are the few examples of ordering costs. It is assumed that ordering cost per order remain
constant. Larger the order size, less is the number of orders and therefore smaller is the total
ordering cost in a given period and vice versa.

Storage Cost:
It includes all costs involved in holding costs example: interest on investment in stocks,
insurance, godown rent, cost of bins, pilferage, spoilage, obsolescence etc. All these costs are
closely related to the number of units held in stores and therefore larger the order size larger is
both the average investing and total storage cost and vice versa.

Stock Out Cost:

The cost arising from non-fulfillment of delivery promises is called the Stock Out cost- like, loss
of sales, loss of goodwill, loss of customers, etc. It is associated with carrying too little
inventory.

Graphic Determination of EOQ: Ordering cost exercises pull in favour of larger order size
because that will result in smaller no. of orders and smaller total ordering cost. Storage cost
exercise pull in favour of smaller order size because smaller order size will result in smaller
average inventory and hence smaller storage cost.

EOQ or least cost order size is determined at a point where both these pulls exactly meet each
other. Thus, EOQ is determined by the intersection of ordering cost curve and storage cost line.

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At EOQ,

Total Ordering Cost = Total Storage Cost; and

The total of the two costs is the least.

So EOQ refers to that size of purchase order for a material which results in making material
available in a given year at a minimum total material related cost (i.e. Ordering Cost + Storage
Cost). At any other quantity of material ordered the total cost of ordering and storage will be
more.

P is the point of intersection of cost line and ordering cost curve. It determines EOQ which is
OL. At OL Order size, total storage cost is PL and total ordering cost is also PL. Total Cost =
Total Storage Cost + Total Ordering Cost = PL +PL = 2PL

At EOQ Total Storage Cost = Total Ordering Cost with the total of the two being the least.
Suppose a smaller order size OL1 is adopted. Then total ordering cost is a1L1 and the total
storage cost is b1L1. Total cost is a1L1 + b1L1 which is more than 2PL. thus OL is the best
order size where the total storage cost is equal to the total ordering cost.

Impact of changes in ordering and storage cost:

In case the ordering cost per order increases, it will be advisable to reduce the total number of
orders in the period. As a result, the size of EOQ will increase. With decrease in ordering cost,
the pull of these costs will get weakened and the size of EOQ will decrease.

With increase in per unit storage costs it will be profitable to maintain thinner inventories. Thus,
the size of EOQ will come down. With decrease in storage cost, the pull of these costs will have
weakened and carrying inventories will become less costly. As a result the size of EOQ will go
up.

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MATHEMATICAL FORMULATION OF EOQ

Determination of EOQ has been explained graphically above. The same can be calculated
mathematically with a greater degree of accuracy as explained below:

EOQ = √ C
2xAxO

EOQ = Economic Order

Where Quantity
A = Annual demand or requirement of the material in units
O = Ordering cost per order
C = Storage cost per unit of material for a period, say, per annum

ASSUMPTIONS IN EOQ MODEL

EOQ Model explained above is based on the following assumptions relating to the degree of
certainty and linearity:
Annual requirement of material can be estimated with reasonable accuracy.
Storage cost per unit of material is constant.
Ordering cost per order is constant.
Daily consumption of materials is more or less constant.
Determination of EOQ is with reference to circumstances prevailing at a point of
time or projected for a given period. In case parameters involved with EOQ
calculations change, then EOQ will also change.

Illustration 1:Purchase Manager has been given an estimated annual purchase requirement of
2000 units of material. Unit price of material is Rs20. Annual cost of carrying inventory is 25%
of cost of material. Ordering cost for an order is Rs50. What order size would you recommend to
the Purchase Manager?
2xAxO
Solution:EOQ = C

2 x 2000 x 50
=
20x
2, 00,000
= 5
40,000
200 units

Maximum Level, Minimum Level and Reorder Level:

In order to avoid over and under investment in materials the management should decide the
maximum and minimum quantity of materials to be stored at any point of time. The fixation of

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maximum level is necessary in order to avoid unnecessary blocking of capital, losses on account
of obsolescence, deterioration of materials, thefts, storage cost etc.

Maximum Level = Re-Order Level + Re- Order Quantity-(Minimum Consumption × Minimum

reorder period)
The fixation of Minimum Level of materials is again a necessary requirement in order to have
un-interrupted production cycle.

Minimum Level = Reorder Level – (average rate of consumption ×average delivery period)

In order to maintain these levels, it is very necessary to determine the re-order level i.e. at what
level of stock the fresh order should be placed for Economic order quantity so that at the time of
the receipt of ordered quantity, the material level should reach at the maximum level.

Re-order Level = Maximum daily consumption × Maximum delivery period.

Average level indicates the average stock held by the concern. It can be calculated with the help
of following formula.

Average Level= (Minimum Level + maximum Level)/2

Or
Average Level= Minimum stock Level+1/2(Reordering Quantity)

Illustration 2: Find the Re-order quantity if consumption is 80-100 units per day, delivery period
is 3-5 days and maximum level is 660 units.

Solution:
Re-order Level = Maximum Consumption × Max Re-Order period.
= 100×5 = 500.
Maximum Level = Re-Order Level + Re-Order Quantity- (Minimum Consumption × Minimum
Re-Order period)
Hence,
Re-Order Quantity = Maximum Level – Re-Order Level + (Minimum Consumption ×Minimum
Re-Order period).
= 660-500+ (80×3) = 400 units.

Illustration 3:A producer has estimated annual requirements of a material as 7200 units. Cost of
placing an order is estimated as Rs 50/order and annual storage cost/unit of material is Rs. 5.
Calculate the optimum order quantity or EOQ. Also show that at EOQ level, total ordering cost
is equal to total storage cost.

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Solution:
c
2AO

5
2x 72,000 x 50

1200 units

Total ordering Cost = No. of orders × ordering cost per order.

Total annual requirements × Ordering cost per order
Order size
=Number of orders × Ordering cost per order
72000 × 50
1200
6 ×50 = 3000

Ordering Size ×
S. 2
1200 × 5 = 3000
2
Therefore, at EOQ = Total Storage Cost = Total Ordering Cost
3000 = 3000

Illustration 4:Find the Maximum Stock level from the following:

Consumption rate is 80-100 units per week
Delivery period is 5-7 weeks
EOQ is 660 units.

Solution:
Maximum Level= Re-order Level + Re-order quantity- (Minimum weekly Consumption ×
Minimum Delivery period)
Re-order Level = Maximum weekly Consumption × Maximum Delivery
Period. = 100×7=700 units
Hence: Maximum Stock Level= 700+660-(80×5) = 960 units

Illustration 5:A company uses 3000 units of material per month. Cost of placing an order is Rs.
200.The Cost per unit is Rs. 20. The reorder period is 4-8 weeks. The minimum consumption of
raw material is 100 units to 350 units whereas the average consumption is 275 units. The
Carrying cost of inventory is 20% per annum. Calculate:
EOQ/ Re-order quantity
Re-order level.
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Solution:

2AO
EOQ = C

Or reorder quantity
Where: A = Annual Usage of Inputs in units
O = Ordering Cost / Order
C = Carry Cost / Unit / annum
EOQ= Economic Order Qty.
2x 36,000 x 200
20 x 20%

36,00,000 =1897.33

b. Re order Level=Maximum consumption x Maximum Delivery period

350 x 8 =2800 units

Illustration 6:A company buys its annual requirement of 36,000 units in six instalments. Each
unit costs Rs.10 and the ordering cost is Rs.250. The inventory carrying cost is estimated at
20% of the unit value per annum. Find the total annual cost of the existing inventory policy.
How much money can be saved by economic order quantity?

Solution:Calculation of the Annual cost of Existing Inventory Policy

Details Amount (Rs)

Ordering cost for six orders @ Rs.250 per order 1,500

Carrying cost @ 20% [i.e. (36,000/6) X 10 X (1/2) X.02] 6,000
Annual cost (Excluding purchase price of material) 7,500

Calculation of Economic Order Quantity

2AO
EOQ = C

2x 36,000 x 250 18000000

= 10 x 20%
= 2

= 3,000 units

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Calculation of the Annual cost if ordering as per EOQ

Details Amount (Rs)

Ordering cost for 12 orders @ Rs.250 per order 3,000

Carrying cost @ 20% [i.e. (36,000/12) X 10 X (1/2) 3,000
Annual cost (Excluding purchase price of material) 6,000

Calculation of saving in cost if ordered as per EOQ

Details Amount (Rs)

Annual cost of existing inventory policy Less: Annual 7,500

Cost by EOQ 6,000
Saving in cost by EOQ 1,500

(Note: Carrying cost will always be calculated on the average no of units carried)

Illustration 7:ABC Company buys in lots of 125 boxes which is a three-month‟s supply.
The cost per box is Rs.125 and the ordering cost is Rs. 250 per order. The inventory carrying
cost is estimated at 20% of unit value per annum. You are required to ascertain:

The total annual cost of existing inventorypolicy.

How much money would be saved by employing the economic order quantity?

Solution:
Calculation of the Annual cost of existing inventory policy

Details Amount (Rs)

Ordering cost of Four orders @ Rs.250 per order 1,000.00

Carrying cost @ 20% [i.e. (500/4) X 125 X (1/2) X .20] 1,562.50
Annual cost (Excluding purchase price of material) 2,562.50

Calculation of Economic Order Quantity

2AO
EOQ = C
25
2x 500 x 250

100 units

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Calculation of the Annual cost if ordering as per EOQ

Details Amount (Rs)

Ordering cost of 5 orders @ Rs.250 per order 1,250.00

Carrying cost @ 20%[i.e. (500/5) X 125 X (1/2) X .02] 1,250.00
Annual cost (Excluding purchase price of material) 2,500.00

Calculation of saving in cost if ordered as per EOQ

Details Amount
(Rs)
Annual cost of existing inventory policy 2,562.50
Less: Annual cost by EOQ 2,500.00
Saving in cost by EOQ 62.50

Illustration 8:A company manufactures 5000 units of a product per month. The cost of placing
an order is Rs. 100. The purchase price of a raw material is Rs. 10/kg. The re-order period is 4 to
8 weeks. The consumption of raw material units is 100kg to 450 kg / week. The average
Consumption is 275 kg. The carrying cost inventory is 20% / annum. You are required to
calculate:
Re-order quantity
Re-order Level
Maximum Level
Minimum Level
Average Stock Level

Solution:
Annual Requirement of Material = 275×52 = 14300

2AO
EOQ = C
2x 14,300
10 x 20%
x 100

1196 units

Re-order Level= Maximum weekly Consumption × Maximum Delivery Period.

= 450 ×8
=3600 Kg.

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Maximum Level= Re-order Level + Re-order quantity- (Minimum weekly Consumption ×

Minimum Delivery period)
3600+1196 – (100×4)
4396kg
Average Delivery Period= (4+8)
2
= 6 weeks.
Minimum Level = Re-order Level - (Average Weekly consumption × Average
Delivery period)
3600- (275×4)
=2500kg.

Average Stock Level = (Minimum Level + Maximum Level)/2

(439+2500)/2
3448kg

Illustration 9:Long life pharmacy produces Sanjivini tonic using two herbs H-1 and H-2. Each
liter of tonic requires 35 centiliters of H-1 and 65 centiliters of H2. Weekly production varies
from 500 liters to 600 liters averaging 550 liters. Delivery period for both the herbs is 2 to 6
weeks. The economic order quantity for H-1 is 800 liters and for H-2 is 1,500 liters Compute:

Re-order level ofH-1;

Maximum level ofH-1;
Minimum Level ofH-1.
Re-order level ofH-2;
Maximum level ofH-2;
Minimum level ofH-2.

Solution:
Re- order level of H-1
(Maximum consumption ×Maximum re-order Period)
(600 X 0.35) X 6 = 1,260 Litres

Maximum level of H-1:

= Re- order level + Re- order Quantity –
(Minimum consumption ×Minimum Re-order Period)
=1,260 + 800 – (500 X 0.35 X 2)
=1,260 + 800 -350 = 1,710 Litres

Minimum Level of H-1:

Re-order level – (Average consumption × Average Re-order Period)
=1,260 - (550 × 0.35 × 4)
1,260 – 770 = 590 Litres

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Re- order level of H-2

(Maximum consumption × Maximum Re-order Period)
(600 X 0.65) X 6 = 2,340 Litres

Maximum of Level of H-2:

Re- order level + Re- order Quantity –(Minimum consumption × Minimum Re- order
period)
2,340+1500 – (500 × 0.65 × 2)
2,340+1500 – 650 = 3190 Litres

Minimum Level of H-2:

Re-order level – (Average consumption × Average Re-order Period)
=2,340 - (550 × 0.35 × 4)
2,340 – 770 = 1570 Litres

Illustration 10:In manufacturing its product P, a company uses two types of raw materials, M-1
and M-2 in respect of which the following information is supplied:
One unit of P requires 16 Kg of M-1 and 6 Kg of M-2 materials. Price per Kg of M-1 is Rs.25
and that of M-2 is Rs.50. Re-order quantities of M-1 and M-2 are 16,000 kg and 7,600 kg. Re-
order levels of M-1 and M-2 12,000 kg and 7,000 kg respectively. Weekly production varies
from 200 units to 300 units averaging 250 units. Delivery period of M-1 is 1 to 3 weeks and that
of M-2 is 3-5 weeks.

Compute:
Minimum Stock level ofM-1.
Maximum Stock level ofM-2.

Solution:

Minimum Stock level ofM-1 = Re-order level – (Normal Consumption X Normal Re-order
Period)
=16,000 – [(250 × 16) × 2]
= 16,000 – 8,000 = 8,000 Kg.

Maximum Stock level of M-2:= Re- order Level + Re- order Quantity – (Minimum consumption
Minimum Re- order Period)
=7,000 + 7,600 – [(200 × 6) × 3]
= 7,000 + 7,600 – 3,600 = 11,000 Kg

Illustration 11:Find out re-order quantity if consumption is 80-100 units per day, delivery
period is 3- 5 days and maximum level is 660units.

Solution:

Re-order level = (Maximum Consumption × Maximum Re- order Period)

= (100 × 5) = 500 units

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Maximum Level:
Re-order level + Re- order Quantity –(Minimum consumption ×Minimum re-order
Period)

Therefore, Re-order Quantity

Maximum level – Re- order level + (Minimum consumption × minimum re-order Period)
660 – 500 + (80 × 3)
660 – 500 + 240 = 400 units

Illustration 12:The following data pertain to Material M-1: SupplyPeriod 4 to 8months

ConsumptionRate:
Maximum 600 units‟ permonth
Minimum 200 units‟ permonth
Average 400 units‟ permonth
Monthly 625 units‟

Storage cost is 40% of stock value, ordering costs are Rs.600 per order. Price per unit is Rs.250.

Compute:
Re-orderlevel; Maximum Stock Level; Minimum Stock Level; Average Stock Level.

Solution:

Re-order Quantity or Economic Order Quantity (EOQ):

= [(2AB)/C]
A = 625 X 12 = 7,500 units
B = Rs.600
C= Rs. 100 i.e. (250 X 0.4)
√ [(2 X 7,500 X 600)/100]
300 units

Re-order level = (Maximum consumption × Maximum Re-order Period)

= (600 X 8) =4,800 units

Minimum Stock level:

Re-order level - (Normal Consumption X Normal Re-order Period)
4,800 – (400×6)
4,800 – 2,400 = 2,400 units

Maximum Stock Level:

Re-order level + Re-order quantity – (Minimum consumption × Minimum Re-order Period)
4,800 + 300 – (200 × 4) = 4,300 units

Average Stock Level

Minimum Level + 0.5 Re-order Quantity
=2,400 + 0.5 × 300
2,400 + 150 = 2,550 units
OR
Average stock level = Minimum level + Maximum
level 2
(2,400 + 4,300) / 2
6,700 / 2 = 3,350 units
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Knowledge Assessment - II

State whether each of the following statement is True and False:

At EOQ total storage cost is equal to the total ordering cost

With increase in ordering cost, EOQ will go up.
With decrease in storage cost, EOQ will come down.
Reorder will lie between minimum and Maximum level.
Larger the no. of orders, lower will be the storage cost.
Re-order level means the quantity to be ordered.
The Economic order quantity means the re order quantity.
Ordering Cost includes the cost of goods also.
Bill of Material and Material requisition are same.
Either of Material Received note or Material Inspection note is to be prepared.

Ans. (1)( True),(2)(True),(3)(False),(4)(True),

(5)(True),(6)(False),(7)(True),(8)(False),(9)(False), (10)(False)

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SESSION –III: VALUATION OF MATERIALS

ISSUING OF MATERIALS

Various products, jobs, processes, contracts, etc. are charged with the cost of materials used by
them. In case, the materials have been exclusively purchased for a job or a contract, these can be
charged at the same rate at which these materials were purchased. But if, the raw materials have
been issued from the stores it becomes necessary to decide about the price which is to be
charged for a material requisition to be used for a particular job or a contract.

MATERIAL REQUISITION:

It is a formal request by the user department to the store keeper for the issue of material. This
request should be duly signed by an officer authorized to make such request. It serves as an
authority to the store keeper to issue materials. It is prepared in triplicate. All the three copies are
signed by the store keeper. One copy is returned to the requisitioning department along with the
materials. Second copy is retained by the store keeper which helps him completing its own
record of issue in Bin Cards/ Store Ledger. The third copy is send to the costing department as a
basis of debiting the requisitioning department. This copy facilitates the ascertainment of the
cost of the job, products and processes for which these materials have been used.

XYZ Ltd.
Material Requisition
------Department -------RequisitionNumber
------------
--------JobNumber Date
To,
The Store Keeper
Please issue the material stated below:
Quantit Remark
S. Description Code y For Cost Bin Store s
No. No. Office Card Ledger
No. folio
Rate Amount

Authorized by-----------------
--- Storekeeper
------------
--------------------IssuedBy ReceivedBy
Bin Card Entered By Rate Entered By
---------CheckedBy

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BILL OF MATERIAL:

A bill of material is a schedule of materials needed for job or unit of production. It is prepared
generally by the production department or an engineering department as soon as the order is
received. It is prepared for non-standardized jobs where exact material requirement differs from
job to job and there is a need to prepare an advance estimate of cost expected to be incurred on
the job. Commonly followed format is as follows:

XYZ Ltd.
Bill of Materials
------Department -------Number
--------JobNumber Date------------
S. Description Code Quantity For Cost Office Bin Store Remarks
No. No. Card Ledger
Rate Amount No. folio

Authorized by---------
----- Storekeeper
-------------------
IssuedBy ------------ReceivedBy
-------
BinCardEnteredBy --------RateEnteredBy
-------------CheckedBy

A bill of material serves the purpose of material requisition also and therefore must be duly
authorized. It is also prepared in triplicate. One copy is returned to the requisitioning department,
one copy to the costing department and one copy is retained by the storekeeper for completing
his records.

COMPARISON BETWEEN BILL OF MATERIAL AND MATERIAL REQUISITION:

Material requisition is an authorization for the store keeper to issue materials. Bill of
materials is a list of materials with complete specification required for a job, contract or
order.
Bill of material can serve as a material requisition but material requisition cannot serve
as bill of material.
Bill of material helps in exercising quantitative control over issues through material
requisition. Withdrawal of material for a job in excess of bill of material may be
indicative of wastage requiring investigations.
Bill of material facilitates preparation of quotation for a job. Material requisition cannot
be used for this purpose.
Both can be used as material requisition.
Both contain description of materials required by the production department.

Underthe following situation both material requisition andbillof material should be prepared:

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In case if the job or process requires longer time for completion, bill of material is
prepared in advance while material requisition is prepared as and when certain materials
are required.
In case system of standard costing is adopted, bill of material can be prepared based on
standard cost and material requisition can be prepared on actual use of material.
Material requisition can be made for issues of material over and above that stated in Bill
of material.

MATERIAL RETURN NOTE:

Sometimes a production department may have materials left over either due to wrong estimation
of requirement for a job or material defect. This excess material should be returned to stores
without delay. Department returning the materials prepares a material return notein triplicate.
One copy, duly signed, is returned by the store keeper to the returning department, one copy is
sent to the costing department as a basis for giving credit to the returning department and the
third copy is retained by the store keeper for completing his own records. Material returned note
contains particulars similar to a material requisition note.

XYZ Ltd.
Materials Return Note
--------Department --------Number
--------JobNumber ------------Date
Quantit
S. Description Code y For Cost Office Bin Store Remarks
No. No. Card Ledger
Rate Amount No. folio

---------------Authorizedby ------------Storekeeper
-----------
--------------------IssuedBy ReceivedBy
Bin Card Entered
By------- ------RateEnteredBy
----------
CheckedBy

MATERIAL TRANSFER NOTE:

Direct transfer of material from one department to another is generally discouraged due to
control considerations. However, in cases where the transfer of material from one job to stores
and from there to another job is costly and inconvenient on account of heavy transport and
handling charges, material may be directly transferred from one job to another provided they are
accompanied with the “material transfer note.” The note will contain the details regarding
materials and the job involved. It will be signed by the foreman of the receiving job and then sent
to the cost office for making appropriate entries. A specimen of material transfer note is given
below:

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XYZ Ltd.
Materials Transfer Note
From:
------Department -------Number
To:
------Department ------------Date
Descriptio Quantit
S. n Code y For Cost Office Remarks
No. No.
Rate Amount

Authorized by--------
-- Received By----------- Returned By--------
--------
RateEnteredBy ----------DebitJobNo. Credit Job No.------
---------CheckedBy

VALUATION OF INCOMING MATERIALS

The receipt of materials means incoming materials meant for conversation into final product.
The incoming materials are to be valued at invoice price subject to trade or quantity discount
plus all expenses incurred up to the point of placing materials in a condition suitable for issuance
from the stores. These Expenses includes:

Transportation including cartage expenses.

Receiving unpacking and inspecting costs.
Insurance and storage costs.
Accounting and purchasing costs.

The basic price of Materials is to be adjusted upwards considering the cost of containers and the
discount availed. The supplier of materials may charge separately for the containers that he has
used for supplying materials. In case these containers are not returnable, their cost must be added
to the cost of materials received. If the containers are returnable at a price less than the cost
charged the difference must be charged to the cost of material received. In case they are to be
returned at full cost charged their cost should not be added to the cost of incoming materials.
Sales Tax, excise duty, custom duty, Insurance etc. are to be added to the purchase price. The
price of material is to be adjusted with respect to discount too. Discount is of three types:

Trade Discount:It refers to allowance which is permitted by the vendor to a purchaser who must
resell the articles. The allowance is permitted to compensate the purchaser for storage, bulk
breaking and delivering small quantities.

Quantity Discount: Such discount is allowed by the supplier to the buyer to encourage him to
place large orders. Both trade and quantity discounts should be taken into account while valuing
the incoming materials.

Cash Discount:Such discount is allowed by the vendor to the buyer to encourage him to make
prompt payment of invoice. It is given only when the debtor gives the payment within the

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stipulated period. As it is a financial incentive, it is not to be included in valuing the incoming

cost of materials.

Illustration 13:Vinayak Limited quotes for material M as under:

Rate
Lot size (kg) (Rs.)

500 20.00
1,250 14.00
2,000 12.00

The supplier allows a trade discount of 25% and cash discount of 4% if payment is made within
two weeks. One container is required for every 50 Kg of materials, and the containers are
charged at Rs. 15 each but credited at Rs. 10 on return. The buyer decides tobuy 2000 Kgs. of
materials from Vinayak Limited. Transport charges ofRs. 1,000 are charged by the supplier.
Calculate the price of 2,000 Kgs. of materials.

Solution:

Details Cost per Kg. Total cost

(Rs.) (Rs.)
2,000Kgs. Materials @ Rs12.00 12.00 24,000
Less: trade discount @ 25% 3.00 6,000
9.00 18,000
Add: charge for containers
For 50 Kg. one container
For 2,000 Kg 40 containers charged at Rs15 each 600
40
Less: credit @ Rs. 10 per container 0 5.00 200
Add: transport charges 0.50 1,000
Total value for costing purposes 14.50 19,200

Note: Cash discount of Rs. 768 on the amount of Rs. 19,200 @4% is a matter of pure finance.
Hence, it has been excluded for costing purpose.

Illustration 14:

The details relating to 10,000 liters of a raw material purchased by Quality Ltd. during July 2016
were as under:

1. Lot size (liters) Rate(Rs.)

Up to 8000 30.00
Between 8000-9,000 28.00
Between 9,000-10,000 25.00
Trade discount of 20%
Additional charge for containers @Rs. 10 for every 50 liters of raw material. Credit
allowed for the return of containers @ Rs. 6 per container of 50 liters capacity.
VAT @ 12.5%on raw material and 5% on containers.
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Total freight paid by Quality Ltd. Rs. 1000.

Insurance @ 4 %(on net invoice value) paid by the purchasing company.
Stores overhead absorbed @ 6% on total purchase cost of raw material.
The entire quantity was received and issued to production. The containers are returned in
the due course. Draw up a suitable statement to show:
Total cost of material purchased.
Unit cost of material issued to production.

Solution:

Details Cost per liter(Rs) Total cost (Rs)

10,000 liters of material @ Rs. 25.00 25.00 2,50,000

Less Trade Discount @ 20% 5.00 50,000
20.00 2,00,000
Add: charge for containers: 0.20 2,000
200 containers charged @Rs. 10
each(10,000 liters/50 liters per
container)
Add Vat:12.5% on 2,00,000(raw 2.50 25,000
material)
5% on Rs. 2000( Containers) 0.01 100
Net invoice value 22.71 2,27,100
Add: Freight Paid 0.10 1,000
Add: Insurance @4%onRs 2,27,100 0.9084 9,084
Total 23.7184 2,37,184
Less credit @Rs. 6 per container 0.12 1,200
Purchase cost 23.5984 2,35,984
Add stores overhead@6% 1.4159 1,41,591
Total value for costing purposes 25.0133 2,50,133

METHODS OF PRICING ISSUES:

The problem of pricing the issues arises only when large quantities of materials purchased at
different prices remain in the stock for a period of time making it difficult to identify which unit
of material was purchased at what price and hence which price is to be charged for which issue.
The pricing of issues only deals with the assigning of pricing to the issues. It has nothing to do
with the actual physical movement of materials.The objective of material pricing are:

To provide satisfactory basis for the evaluation of closing stock to prepare the final accounts.
To charge the cost of material used for measuring the cost of production and cost of
sales.When materials are issued from the stores to the various production departments, the
pricing of the issued materials can be done according to different methods. Each method has

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its own area of suitability depending on the nature of materials, price trends and the
management policy.

FIRST IN FIRST OUT (FIFO):

Under this method, issues are priced on the assumption that materials purchased first are issued
first. The actual physical movement may or may not follow this pattern. Materials issued are
priced at the oldest price recorded in stores lodger for materials in stock. So the closing stock of
material is valued at the price of the latest purchases.

The method is particularly suitable in case of perishable materials and in the period of falling
prices. The issues are priced at oldest prices which are higher and hence facilitate the recovery
of higher costs. The closing stock is valued at the latest prices which are lower. These results in
lower value of closing stock and hence lower book profits thereby lower tax liability. In case of
rising prices, the effect is the reverse.

Advantages:

Most suitable in Perishable product as pricing method more on less corresponds with actual
movement of Materials.
Simple to understand.
All issues are priced at cost price, hence entire cost of materials are recovered.
The method results in lower book profits and hence lower tax liability during the period of
falling prices.
The value of closing stock is realistic as it is valued at the price of latest purchases.

Disadvantages:

The issue price differs for different issues of the same quality of raw material at the same
time. Therefore cost comparisons get distorted.

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During the period of rising prices, it results in higher book profits and therefore high tax
liability. This is because closing stock appearing on the credit side is valued at higher prices
and the cost ofproduction appearing on the debit side is valued lower prices.
For pricing one material requisition more than one price may be involved and hence leads
tohigher probability of clerical errors.

LAST IN FIRST OUT (LIFO):

Under this method, issues are priced on the assumption that material purchased last are issued
first, though the actual physical movement of materials may not follow this pattern. Issues are
priced at the price of latest purchases of materials remaining unissued at per records. As a result
the closing stock gets priced at the price of the earliest purchases of materials lying unutilized as
per records. The method is particularly useful in the case of rising prices. The production is
charged at the price of latest purchases while the closing stock at the earliest prices which are
lower. This leads to lower book profit and hence less tax liability. In case of falling prices the
effect is reverse.

Advantage:
Method gives good matching of sales and cost of sales.
Method is simple to understand.
Issues are priced at cost and hence entire cost of material used is recovered from
production.
It results in lower book profits and hence lower tax.

Disadvantages:

The issue price differs in different issues and hence distorts cost comparison.
During the period of falling prices this method gives high profits and higher tax liability.
For pricing are material requisition more than one prices may be involved and hence
higher probability of clerical errors in calculations.

AVERAGE COST METHOD:

Average costs methods are based on the assumptions that the material purchased in different lots
are stored together and their identity gets lost. Therefore these materials should be charged to
production at an average price. This issue price can be calculated either on the basis of simple
average method or on the basis of weighted average method.

Total of different prices of Materials in

the stock from which the materials are
Simple average Price = No. of prices used in calculating
total
value.

The method is very simple but is unscientific and can offer highly misleading and absurd results.
This method can also result in large under absorption or over absorption of material cost.
Therefore, this method is generally not used except when all the purchases made are more or less

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in equal lot size. In such situations, simple average method will give the same result as
weighted average method.

Weighted average Price = Total Cost of material in the stock as on the issue date
Total quantity of material in the stock

This method considers the prices as well as the quantity of different lots of material in stores.
Before each issue new weighted price is calculated.

Advantages:

The method is systematic and not subject to manipulations.

The method recovers full cost of materials from the production.
It smoothensthe fluctuations in the issue prices. So different material requisitions will be
charged almost the same price.
The issue price is generally close to market price.

Disadvantages:

Fresh rate needs to be calculated after every fresh receipt of materials, which generally
comes in fraction.
Issue price is different from the actual cost of materials for the individual‟s issues and so
some nominal profit or loss will appear simply because of the use of average method.

Illustration 15:From the following transaction prepares stores ledger account using FIFO:
2016 Receipts 2016 Issues
July1 opening balance 2000units @Rs10 July 3 SRN 160 800unit
July4 purchases GRN75 3000units @Rs11 July 6 SRN 168 1500unit
July8 purchases GRN82 2500units @Rs13 July 11SRN 181 1700unit
July15 purchases GRN91 1500units @Rs15 July 13 SRN 187 1200unit
July16 purchases GRN93 1000units @Rs16 July 17 SRN 194 1800unit
July18 purchases GRN96 1200units @Rs17 July 19 SRN 197 2200unit
July24 purchases GRN112 4000units @Rs19 July 21 SRN 201 500unit
July 27 SRN 210 2900unit

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Solution:

Stores ledger account (FIFO)

Receipts Issue Balance

Date Ref. Qty Rate Amount Date Ref. Qty Rate Amount Qty Rate Amount
2016 Unit Rs. Rs. 2016 Unit Rs. Rs. Unit Rs. Rs.
July 1 Bal. - - - - - - - - 2000 10 20000
b/d
- - - - - July SRN 800 10 8000 1200 10 12000
3 160
July 4 GRN75 3000 11 33000 - - - - - 1200 10 12000
3000 11 33000
- - - - - July SRN 1200 10 12000 2700 11 29700
6 168 300 11 3300
July 8 GRN 2500 13 32500 - - - - - 2700 11 29700
82 2500 13 32500
- - - - - July SRN 1700 11 18700 1000 11 11000
11 181 2500 13 32500
July SRN 1000 11 11000 2300 13 29900
13 187 200 13 2600
July 15 GRN 1500 15 22500 - - - - - 2300 13 29900
91 1500 15 22500
July 16 GRN 1000 16 16000 - - - - - 2300 13 29900
93 1500 15 22500
1000 16 16000
- - - - - July SRN 1800 13 23700 500 13 6500
17 194 1500 15 22500
1000 16 16000
July 18 GRN 1200 17 20400 - - - - - 500 13 6500
96 1500 15 22500
1000 16 16000
1200 17 20400
- - - - - July SRN 500 13 6500 800 16 12800
19 197 1500 15 22500 1200 17 20400
200 16 3200 - - -
July SRN 500 16 8000 300 16 4800
21 201 1200 17 20400
July 24 GRN 4000 19 76000 - - - - - 300 16 4800
112 1200 17 20400
4000 19 76000
- - -- - - July SRN 300 16 4800 2600 19 49400
27 210 1200 17 20400
1400 19 26600

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Illustration 16.Prepare stores ledger account materials on LIFO from the information given
in Illustration 15.

Solution:

Stores Ledger Account (LIFO)

Receipts Issue Balance

Date Ref. Qty Rate Amount Date Ref. Qty Rate Amount Qty Rate Amount
2016 Unit Rs. Rs. 2016 Unit Rs. Rs. Unit Rs. Rs.
July 1 Bal. - - - - - - - - 2000 10 20000
b/d
- - - - - July SRN 800 10 8000 1200 10 12000
3 160
July 4 GRN75 3000 11 33000 - - - - - 1200 10 12000
3000 11 33000
- - - - - July SRN 1500 11 16500 1200 10 12000
6 168 1500 11 16500
July 8 GRN 2500 13 32500 - - - - - 1200 10 12000
82 1500 11 16500
2500 13 32500
- - - - - July SRN 1700 13 22100 1200 10 12000
11 181 1500 11 16500
800 13 10400
- - - - - July SRN 800 13 10400 1200 10 12000
13 187 400 11 4400 1100 11 12100
July 15 GRN 1500 15 22500 - - - - - 1200 10 12000
91 1100 11 12100
1500 15 22500
July 16 GRN 1000 16 16000 - - - - - 1200 10 12000
93 1100 11 12100
1500 15 22500
1000 16 16000
- - - - - July SRN 1000 16 16000 1200 10 12000
17 194 800 15 12000 1100 11 12100
700 15 10500
July 18 GRN 1200 17 20400 - - - - - 1200 10 12000
96 1100 11 12100
700 15 10500
1200 17 20400
- - - - - July SRN 1200 17 20400 1200 10 12000
19 197 700 15 10500 800 11 8800
300 11 3300 - - -
- - - - - July SRN 500 11 5500 1200 10 12000
21 201 300 11 3300
July 24 GRN 4000 19 76000 - - - - - 1200 10 12000
112 300 11 3300
4000 19 76000
- - -- - - July SRN 2900 19 55100 1200 10 12000
27 210 300 11 3300
1100 19 20900

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Illustration 17:Prepare stores ledger account by simple Average Method and Weighted Average
Method from following information:

Receipts Issued
2016 2016
July1 GRN30 4000units @Rs5 July 4 MRN 101 1200unit
July5 GRN 37 2000units @Rs6 July 7 MRN 112 1800unit
July11 GRN 42 1000 units @Rs11 July 12 MRN 119 1600 unit
July15 GRN 46 1500 units @Rs14 July 17 MRN 127 900unit
July20 GRN 51 3000 units @Rs13 July 21 MRN 132 2800unit
July25 GRN 56 2500 units @Rs13 July 28 MRN 138 2600unt

Solution:

Stores Ledger Account (Simple Average Method)

Receipts Issue Balance

Date Ref. Qty Rate Amount Date Ref. Qty Rate Amount Qty Rate Amount
2016 Unit Rs. Rs. 2016 Unit Rs. Rs. Unit Rs. Rs.
July 1 GRN 4000 5 20000 - - - - - 4000 5 20000
30
- July MRN 1200 5 6000 2800 5 14000
4 101
July 5 GRN 2000 6 12000 - - - - - 2800 5 14000
37 2000 6 12000
- - - - - July MRN 1800 5.5 9900 1000 5 (26000-
7 112 (5+6) 2000 6 9900)=
/2 16100
July GRN 1000 11 11000 - - - - - 1000 5 16100
11 42 2000 6
1000 11 11000
- - - - - July MRN 1600 7.33 11728 1400 6 (27100-
12 119 (5+6+11) 1000 11 11728)=
/3 15372
July GRN 1500 14 21000 - - - - - 1400 6 15372
15 46 1000 11
1500 14 21000
- - - - - July MRN 900 10.33 9297 500 6 (36372-
17 127 (6+11+14) 1000 11 9297)=
/3 1500 14 27075
July GRN 3000 13 39000 - - - - - 500 6 27075
20 51 1000 11
1500 14
3000 13 39000
- - - - - July MRN 2800 11 30800 200 14 (66075-
21 132 (6+11+14+13) 3000 13 30800)=
/4 35275
July GRN 2500 13 32500 - - - - - 200 14 35275
25 56 3000 13
2500 13 32500
July MRN 2600 13.33 34658 600 13 (67775-
28 138 (14+13+13) 2500 13 34658)=
/3 33017

Simple Average Method is considered unscientific and can lead to absurd results:
On July 7, 1800 units are issued at the simple average price of 5.5 ((5+6)/2) at the issue
amount of 9900 i.e. (1800*5.5). The total purchase value of materials on the same day is
26000 (2800*5+2000*6). The question arise, that if we suppose FIFO along with simple

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average then the cost of these 1800 units is 9000 (1800*5) while we are charging 9900
according to the method. So the units are overcharged by 900.

The cost of the units remained in the balance are of the value of 17000 (1000*5+2000*6)
but the balance has been written as 16100 (26000-9900) according to the mathematical
th
formula. Hence, the balance of materials in the store ledger as on July 7 is undervalued
by 900.
These disadvantages have been discussed only on the basis of assumption that oldest
stock has been issued first. Thisweakness of over valuation/undervaluation will be there
in all the methods in which the price is derived from the actual prices paid for the
purchases.

Stores Ledger Account (Weighted Average Method)

Receipts Issue Balance

Date Ref. Qty Rate Amount Date Ref. Qty Rate Amount Qty Rate Amount
2016 Unit Rs. Rs. 2016 Unit Rs. Rs. Unit Rs. Rs.
July 1 GRN 4000 5 20000 - - - - - 4000 5 20000
30
- July MRN 1200 5 6000 2800 5 14000
4 101
July 5 GRN 2000 6 12000 - - - - - 4800 5.4167 26000
37
- - - - - July MRN 1800 5.4167 9900 3000 5.4167 16250
7 112 (26000/4800)

July GRN 1000 11 11000 - - - - - 4000 6.8125 27250

11 42
- - - - - July MRN 1600 6.8125 10900 2400 6.8125 16350
12 119 (27250/4000)
July GRN 1500 14 21000 - - - - - 3900 9.5769 37350
15 46
- - - - - July MRN 900 9.5769 8619 3000 9.5769 28731
17 127 (37350/3900)
July GRN 3000 13 39000 - - - - - 6000 11.2885 67731
20 51
- - - - - July MRN 2800 11.2885 31607 3200 11.2885 36124
21 132 (67731/6000)
July GRN 2500 13 32500 - - - - - 5700 12.0392 68624
25 56
July MRN 2600 12.0392 31302 3100 12.0392 37321
28 138 (68624/5700)

SELECTION OF PRICING METHOD:

All the methods of pricing of issues have advantages and disadvantages and are suited under
different situations. An appropriate method is one which gives good matching of costs against
revenues and produces meaningful cost figures for effective cost control and analysis. No single
method can be appropriate under all circumstances. The choice of the method depends upon the
following factors:
Nature of materials
Management desire.
Fluctuation in the prices of materials.
Frequency of purchases and issues.
Nature and size of business.
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Generally, if prices are falling FIFO is preferred. If prices are rising, LIFO is preferred while
if prices are fluctuating, weighted average price method is preferred.

Knowledge Assessment – III

Which of the following is “True” or “False”

Pricing of issue of materials is closely connected with the actual physicalmovements

of units of material.
Issue prices have an impact on book profits of the firm.
Issue prices fluctuate more in the case of weighted price method than under LIFOand
FIFO.
Method of pricing issues aims at charging material cost to production.
Pricing of issue of raw material do not have any impact on the valuation of stock.
Under FIFO book profits are higher than under LIFO of pricing under the period
ofrising prices.
FIFO does not generally give a good match between the cost incurred and costcharged
to the product.
Under FIFO method, units purchased first are physically issued first.
LIFO gives higher value of closing stocks during Inflationary period than that ifFIFO
method of pricing issues is used.
Simple average may give higher, lower or equal value of closing stock when
compared to the weighted average method of valuing the closing stock.
FIFO is generally suitable for perishable products.
As per LIFO method of pricing, issues are close to current economic values.
Re- order level means the quantity to be ordered.
Purchase order is an order to a stores department to issue materials.
Valuation of stock under FIFO and LIFO are same.

Ans: (1)( False),(2) (True),(3)(False),(4)(True),(5)(False), (6) (True),(7) (True), (8)

(True),(9)(False),(10) (True),(11) (True), (12)(True), (13)(False),(14) (False),
(15)(False)

KEYWORDS

Bill of Material:A schedule of materials needed for the job or a unit of production.
Bin card:The card hung outside each bin recording the physical movement of inflows
and outflows of material and hence showing the balance of quantity after every
transaction.
Direct Material: Materials that can be conveniently and wholly identified with specific
units of output/ product/Job/ contract/ process/ or operations. These become a part of
the finished product itself.
Economic Order Quantity:The most economical size of the order at which the total
ordering cost and total carrying cost are equal and minimum.

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Indirect Material: Materials that cannot be classified as direct are called as indirect
materials. Indirect materials do not physically constitute a part of the final product.
Material Control: Material Control is a system which ensures provision of material in
the right quantity, of the right quality, at the right time with minimum investment.
Material Requisition:A formal request by the user department to the store keeper for
the issue of material.
Material Return Note:It is a note initiated by department returning the material and
duly acknowledged by the store keeper.
Material Transfer Note: It is a note initiated by the department transferring the
material and duly acknowledge by the receiving department.
Periodic Inventory System: A system which computesthe stock periodicallyby relying
on physical count without keeping daily records of units sold or in hand.
Perpetual Inventory System:A system that keeps a running, continuous record that
tracks inventories and cost of goods sold on a transaction to transaction basis.
Pricing the Issues: When the materials are purchased at different prices, the decision
as to which price to be charged for the issue of materials.
Purchase Order: It is the legal authorization to the supplier of the goods to deliver the
goods as per the description and terms and condition mentioned therein.
Quantity Discount: The discount allowed by the supplier for the bulk purchases.
Larger orders give the economies of scale, which is passed on to the purchaser.
Stores Ledger: It is the ledger of materials maintained by the store keeper showing the
purchases, issue, and balance after every transaction both in quantity and value.
Trade Discount: The allowance which is allowed by the seller to a buyer who has to
resell the articles. It is allowed as a matter of trade policy. This is allowed to
compensate cost of storage, breaking bulk and selling and delivering in small
quantities.
Valuation of Stock:It is the valuation of the closing stock will differ depending on the
price of issue. This will differ under different methods of pricing.

SUMMARY

Material is the basic substance that is transformed into a useable product.

Semi-finished material are those materials which are not 100% finished or completed in
all respects.
Finished components are those which can either be consumed or used as raw material
for manufacturing of the final product.
Material Control is a system which ensures the provision of material in the right
quantity, of the right quality, at the right time with minimum investment.
The steps for evolving a sound MCS are Material Planning, Material Purchasing,
Material Receiving, Material Inspection, Material storage and Material Issue.
The purchase process starting with the purchase requisition, invitation of tenders and
placing the purchase order.
The system provides for proper procedure for Receipt of material, Inspection of
materials and then transfer to either the stores department or directly to the production
department.

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For a good store keeping, different documents like Bin Card, Bill of Material, Material
Requisition and Stores Ledger has to be maintained.
Stores keepers use different techniques of material control by maintaining different
stock levels.
Economic order quantity is that size of order at which ordering cost and total carrying
cost are equal and the total of two is least.
The pricing of materials issued are based on different assumptions leading to different
method of issues. Example: FIFO, LIFO, Simple Average and Weighted Average
Methods.

EXERCISE QUESTIONS

Short Answer Questions:

What do you mean by Material?

What do you mean Direct Material Cost?
What do you mean by Indirect Material Cost?
Define Material Control.
List all the steps required for an efficient Material Control System.
Write short on the following
Economic order quantity
Average method of pricing issues
Reordering level
Bin card with its specimen
Material transfer note
Minimum stock level
Differentiate between:
Purchase requisition and purchase order
Bin card and stores ledger
Bill of material and stores requisition
Material requisition and Material transfer note.
Explain the nature of problem of Pricing of issues. Why does this problem arise?
What are the advantages of FIFO and LIFO?
Under the conditions of rising prices, which of the method LIFO or FIFO would you
recommend and why?
Explain any two demerits each of FIFO and LIFO Method of pricing the issues?
What factors have to be considered while selecting a method of pricing the issues?
Discuss the circumstances under which average method of pricing the issues are
preferred and why?

Long Answer Questions:

What is Material Control Process?State its advantages.

State the basic requirements and of objectives of Material Control.
What do you mean by economic order quantity? Discuss its assumptions.
What are the different stock levels? Explain each of them briefly.

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What is importance of dividing the Material in direct and indirect when both the
cost has to be taken while finding out the cost of production? Comment.
Describe the meaning, objectives and basic principles of material control system.
What is reordering level? Explain its relationship with minimum and maximum
stock level.
Discuss the functions and advantage of centralized purchasing.
What do you mean by Inventory control? Discuss the various objectives of
Material control.
Discuss the meaning and treatment of “quantity, trade and cash discount”.
“Ordering cost and carrying cost are equal at EOQ level” Discuss.
“Problem of pricing the issues only deals with assigning of prices to the issues. It
has nothing to do with actual physical Movement of materials.” Discuss.
Explain two considerations which should be taken into account while selecting a
proper method of pricing the issues.
Discuss the Important systems of pricing material issues to production.
Explain the FIFO and LIFO method of valuation of material issues. Discuss the
effects of rising and falling prices on these two methods of pricing the material issues.
Under the condition of rising prices, which of the following two methods of
pricing material issues would you recommend and why?
Write short notes on:
LIFO vs. FIFO
Simple average vs.Weighted average method of charging issue of material.

Numerical Questions:

From the following information calculate the Economic Order Quantity and the number
of orders to be placed, in one quarter of the year.
Quarterly consumption of material 2000kg.
Cost of placing one order Rs50
Cost per unit Rs40
Storage and carrying cost 8% on average inventory.

(Answer. EOQ=500Kg. No. of orders=4)

Following data relate to material „Y‟. Find (a) Re- Order Level, (b) Minimum Level, and
(c) Maximum Level.
Normal usage 450 units per week Re-Order Quantity 3,200 units
Maximum usage 750 units per week Re-Order Period 3-5 weeks
Minimum usage 300 units per week

(Answer. (a) 3,750 units (b) 1,650 units (c) 6,050 units)

About 50 items are required everyday for a machine. A fixed cost of Rs. 50 per order is
incurred in placing the order. The inventory carrying cost per item amount to Re. 0.02 per
day. The lead period is 32 days. Compute (a) Economic Order Quantity, (b) Re-Order
Level.

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(Answer. (a) 500 items, (b) 1,600 items)

Maya Aids Co. manufactures a special product „B‟. The following particulars were
collected for the year 2016.
Monthly demand of „B‟ 1,000 units
Cost of placing an order Rs100
Annual carrying cost per unit Rs15
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 from the above:

Re-order Quantity
Re-order Level
Minimum Level
Maximum Level
Average Stock Level.

(Answer. i.186 units’ ii. 450 units iii. 200 units iv. 536 units v. 368 units)

Calculate the Minimum Stock Level, Maximum Stock Level and Re-ordering Level from
the following information:
Minimum consumption: 100 units per day
Maximum consumption: 150 units per day
Normal consumption: 120 units per day
Re-order Period: 10-15 days
Re-order Quantity: 1500 units
Normal Re-order Period: 12

(Answer. 810 units, 2250units and 250 units)

From the following data, calculate the (i) Maximum Level, (ii) Minimum Level and (iii)
Re-ordering Level:
Re-order Quantity: 1500 units‟ Minimum consumption: 250 units per week
Re-order Period: 4-6 weeks Normal consumption: 300 units per week
Maximum consumption: 400 units per week

(Answer. (i) 2,900 units (ii) 900 units (iii) 2,400 units)

Two components „X‟ and „Y‟ are used as

follows: Normal usage: 50 units per week each
Re-order quantity: X 300 units, Y 500 units
Minimum usage: 25 units per week each Re-order
period: X 4 to 6 weeks, Y 2 to 4 weeks Maximum
usage: 75 units per week each
Calculate, for each component: (a) Re-order Level, (b) minimum Level, (c) Maximum
Level and (d) Average Stock Level.
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You are presented with the following information of Online engineering Ltd. relating to
the first week of April 2016.

Days Receipts(Rate per Unit) Rate per Unit Issue (Units)

1st 40 15.00 -
2nd 20 16.50 -
3rd - - 30
4th 50 17.10 -
5th - - 20
6th - - 40

Calculate the cost of material issued under (1) FIFO (2)LIFO Method (3) Weighted
Average Method of issue of materials and value of closing stock under the methods
aforesaid.

(Answer: cost of issues 1443 and closing stock 20 units @ Rs 17.10 (ii) cost of issues
1485 and closing stock 20 units @ 15.00 (iii)Cost of issues Rs 1445 and closing Stock20
units at Rs 330.)

From the following particulars of material X, maintained the stores ledger according to
FIFO and LIFO methods:
10,000 units @5
1.1.2016 Opening stock each
3.1.2016 Purchased 9,000 units @5 each
10.1.2016 Issue 12,000 units
12.1.2016 Purchased 8,000 units @5 each
16.1.2016 Purchased 3,000 units @5 each
18.1.2016 Issue 4,000 units
20.1.2016 Issue 6,000 units
21.1.2016 Purchased 3,000 units @5 each
25.1.2016 Issue 4,000 units

(Answer: Closing stock FIFO 4000 units @ Rs 6.00 andClosing stock LIFO 4000 units
@ Rs 5.00)

Show how the items given below relating to purchases and issue of raw materials will
appear in the stores ledger card using weighted average method of issuing the materials.
100 units @20
1.2.2016 Opening stock each
100 units @22
5.2.2016 Purchased each
11.2.2016 Issue 150 units
200 units @23
22.2.2016 Purchased each
24.1.2016 Issue 150 units
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28.1.2016 Issue 50 units

(Answer:Rs 21; Rs22.67; Rs 22.67)

Prepare a stores ledger using weighted average method of pricing the issue from the
following transactions.

1.4.2016 Opening 50 units @5 each

stock
3.4.2016 Issue 20 units
10.4.2016 Purchased 120units@Rs 5.50 each
15.4.2016 Issue 70 units
20.4.2016 Purchased 130 units @5.60 each
28.4.2016 Received 10 units which were issued
back on 15th
30.4.2016 Issue 100 units

(Answer: 20 units @ Rs5, 70 units @Rs 5.40, 100 units @Rs 5.516, closing stock 120
units @ Rs 5.516)

12. From the following information for the year 2015-16, prepare the income statement of the
year and show the value of the Closing stock on the basis of (i) FIFO (ii) LIFO (iii)
weighted average method.

Opening Stock 1000 units @15 per unit.

Purchases during the year 30,000 units @ Rs 17 per unit.
Sales during the year 25,000 units @ Rs 20 per unit.

(Answer: Closing Stock: FIFO:( 6000*17)=1,02,000 LIFO:(1000*15+500*17)=1,00,000

Weighted average: (6000*5,25,000/31000)=1,01,613)

The stores ledger account of material C in books of Murli producer Ltd. revealed the
following transactions for the month of December.
Dec. 1 Opening stock 200 kg @ Rs. 7.50 per kg
Dec. 5 Received from supplier S1400 kg @Rs. 7.75 per kg (GRN No. 448)
Dec. 8 Issued to production department 240 Kg (S.R. No. 833)
Dec. 10 Issued to production department 160 kg (S.R. No. 897)
Dec. 12 Received from supplier S2500 kg @ Rs.7.90 per kg (GRN No. 455)
Dec. 15 Issued to production department 400 kg (S.R. No. 912)
Dec. 16 Received from supplier S3 250 kg @ Rs. 8.00 per kg (GRN No. 461)
Dec. 19 Received from supplier S1 600 kg @ Rs. 8.25 per kg (GRN No. 469)
Dec. 21 Issued to production department 350 kg (S.R. No. 946)
Dec. 24 Issued to production department 260 kg (S.R. No. 959)
Dec. 27 Issued to production department 340 kg (S.R. No. 974)

Where GRN denote goods received notes. SR denotes stores requisition.

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You are required to price the issue and draw out the closing balances in the stores ledger
account under the pricing method suitable for anyone of the following two alternatives: (a)
The closing balances should be closely related to the current prices. (b) The material cost
charged to production should be closely related to current prices.

(Answer Closing stock 200 units. FIFO Rs. 1,650; LIFO Rs. 1,500)
(Hint. When FIFO method is used, the closing stock is closely related to current prices and
when LIFO method is used, charge to production is closely related to current prices.)

Show the stores ledger entries as they would appear using:

The weighted average method
The LIFO method
of pricing issues in connection with the following transactions:
Units Value
Rs.
March 1 Balance b/f 300 600
March 2 Purchased 200 440
March 4 Issued 150 -
March 6 Purchased 200 460
March 11 Issued 150 -
March 19 Issued 200 -
March 22 Purchased 200 480
March 27 Issued 250 -
In a period of rising prices such as above, what are the effects of each method?

(Answer. Closing stock (a) Rs. 342; (b) Rs. 300)

15. Yamani Ltd. has purchased and issued the material in the following order:
3,000 units @ Rs. 3 per
July 1 Purchased unit
6,000 units @ Rs. 4 per
July 4 Purchased unit
July 6 Issued 5,000 units
7,000 units @ Rs. 4 per
July 12 Purchased unit
July 17 Issued 8,000 units
3,000 units @ Rs. 5 per
July 22 Purchased unit
July 25 Issued 1,000 units
Ascertain the quantity of closing stock as on 31th July and state its value (in each case) if issues
are made under the following method: (a) average cost (b) FIFO (c) LIFO.

(Answer. 5,000 units; (a) Rs. 22,200; (b) Rs. 23,000; (c) Rs. 19,000)

As on 13.12.2016

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UNIT: 3 - DIRECT LABOUR AND DIRECT EXPENSES

Unit UNIT TITLE: DIRECT LABOUR AND DIRECT EXPENSES

Code 3
Location: Duration:
Classroom SESSION 1: MEANING OF DIRECT LABOUR
Learning Outcome Knowledge Performance Teaching and
Evaluation Evaluation Training Method
1.Understanding about 1. Explain the 1.Describe the Interactive
the meaning of direct meaning of relevance of Lecture:
labour. direct labour. studying direct Introduction to
labour. direct labour
2.Clarity about the 2. Differentiate 2. Explain the
objectives of the between direct relevance of Activity:
studying direct labour and separating of direct Conceptual Case
labour. indirect labour. and indirect labour. discussion
3.Understanding about 3. Name the 3. Explain the role
various departments departments to of various
tocontrol over be established departments to
labour cost. for controlling control over labour
labour cost. cost.
Location: SESSION 2: LABOUR REMUNERATION
Class 1.Clarity about 1.Discuss various 1.Discuss various Interactive
room or methods of methods of wage methods of wage Lecture:
Factory providing labour payment. payment under Procedure of
Premises remuneration. 2.Describe the time wage Wage payment
advantages or system.
disadvantages of 2.Discuss various Activity:
using different methods of wage Preparation of
methods of wage payment under wage abstract
payment to an piece wage using industry data
employee. system.
3.Describe the
advantages or
disadvantages of
using different
methods of wage
paymentto an
employer.
SESSION 3: INCENTIVE PLANS ACCORDING TO VARIOUS WAGE
METHODS
1.Understanding of the 1.Define the 1.Identify the Interactive
various incentive concept of incentive plans Lecture:
plans according to incentive plan. most prevalent Introduction to
different wage 2.Discuss incentive ina particular incentive plans
o
methods. plan according to industry r in offered to labour.

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the time wage general.

system
3.Elaborate various
incentive plans
according to the
piece wage
system.
SESSION 4: LABOUR TURNOVER AND DIRECT EXPENSES
1.Understanding the 1. Describe methods 1.Explain the Interactive
concept of Labour of measurement usefulness of Lecture: Procedure
Turnover. of labour measuring labour of determination of
turnover. turnover in the Labour Turnover
industry.
2.Learned the 2.Explain the Activity:
formulae of methods of Determination of
determination of measurement of labour turnover on
labour turnover. labour turnover. Industry data

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UNIT: 3 - DIRECT LABOUR AND DIRECT EXPENSES

Learning Objectives:

After reading this unit, students will be able to:

Understand the meaning of direct labour and its importance;

Understand the difference between direct and indirect labour;
Explain the meaning and causes of labour turnover and methods of its measurement;
Describe various methods of time keeping and time booking;
Understand the mechanism of calculating wages according to time rate and piece rate
system of labourremunertion;
Discuss various incentive plans of labour remuneration and their effect on cost and
profit; and
Explain the meaning of certain key terms.

Rapid development of the technology and invention of advanced machines has reduced the role
of human resources in the modern business organizations;however, their intervention cannot be
eliminated from manufacturing or the services industry, therefore, labour is the most critical
component of any business organisation.
SESSION 1: MEANING OF DIRECT LABOUR

Labour is the work force which contributes towards the completion of the manufacturing process
of any organisation. Without manual horse power only machines cannot complete the process.
Labour can be bifurcated in two parts; direct labour and indirect labour. Labour which is directly
associated with a manufacturing process or his contribution is directly identifiable with a
particular process will be called as direct labour while when the contribution of the labour cannot
be associated with a particular manufacturing process or specifically not identifiable with a
particular product or process is called as indirect labour. For example in a factory of readymade
garments, wages paid to a tailor are direct wages.

While in some cases it is very complicated to differentiate between direct and indirect labour. A
worker might be engaged in doing a particular work concerned with manufacturing commodity
and after an hour the same worker might be placed on a different job say time-keeping, repairing
etc. In aforementionedscenarios initial one hour will be treated as direct and later hours will be
treated as indirect.

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CONTROL OVER LABOUR COST

Labour majorly contributes to the growth and development of any organisation. Without efficient
and effective utilization of man power resources organisation cannot achieve the goal of profit
maximization by reduction in cost and improvement in quality of the products. Generally,
following five departments are established by the organisation to control cost.

Personnel Department
Engineering and Works Study Department
Time-Keeping Department
Pay- Master‟s Department
Cost Accounting Department

PERSONNEL DEPARTMENT

The personnel department is responsible for hiring the right person at the right place at the right
time. Role of personnel department is not over with the hiring of the workforce rather they have
to train them before sending them to the workplace. Whenever a new worker is employed, the
Personnel Department sends a notification to the time keeping department and paymaster
department for their compensations.

Personnel department maintains following important records:

The personnel department first receives the following requisition slip from the concerned
departments who are having need of the workforce. After receiving the requisition records will
be checked by the personnel department about the availability of the employees in the required
category. If required employees are not available in the organisation then action will be taken to
recruit more employees. Following is the format of Labour Requisition Slip.

LABOUR RECRUITMENT REQUISITION

Department…….
Requisition No…………….

Date…………………………….
Kindly arrange for workers of the following categories for my Department with effect from
Number of Category Job Description Remarks
employees Specification
requisitioned

Requisitioned by…………..
Approved by……………

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EMPLOYEE’S RECORD CARD

Employee’s Record Card

Name………………………
Clock Number…………………………
Address…………………..
Marital status…………………………
Date of Birth……………
Previous Experience……………….
Education……………….
Grade…………………………………….
Date of Employment…….
Starting Pay…………………………..
Department……………….
Engaged as……………………………
Category……………..
Previous Employer……………
Exit Date…………….
Reasons of Exit………..
PARTICULARS OF CHANGES IN PAY AND SERVICE
Date Occupation Grade Pay Reasons for
Change

ENGINEERING DEPARTMENT

This department is committed to provide congenial work environment to its employees also
controlling over the production methods and processes followed in the various departments. This
department is majorly involved in planning and conducting motion studies, work studies, time
studies, job analysis and setting piece rates, providing safe and efficient working conditions,
supervising production activities in various production departments.

Work Study

Work study may be defined as a technique of management which involves analytical study of
jobs/operation with the object of determining the exact operations to be performed and
measuring the work content of jobs. The object of work study is overall improvement by saving
time, reducing loss of materials, developing new methods of work, etc..

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Time Study

Time study is helpful in determining the standard time for an operation on the basis of the
observations of the ongoing operations. Its major motive is to control the labour time and cost
also to run the operations smoothly.

Motion Study

Motion study is conducted by recording the movement of the workers and machines on the job.
The purpose of the motion studies is to replace the ineffective processes or methods of work by
introducing effective, efficient and least tiring processes. Motion studies are conducted through
observing various factors likeuse of both hands without undue straining, linking motions to each
other in the most economical sequence, using equipment which would both speed up the work
and make it easier to perform.

Job Analysis

Job analysis is concerned with the preparation of job description. Job description refers to the
skill set required to perform a particular jobsmoothly and efficiently.

Job Evaluation

Job evaluation is done to analyze the worth of a particular job whether the job is useful for the
organisation or not.

TIME-KEEPING DEPARTMENT

The time-keeping department plays important role in the accounting and controlling of labour
cost. The main function of this department is to accurately record the time spent by each worker
on the work place and it will be forwarded to the pay-master department then this department
will process it further to prepare the compensations of the employees.

There are various methods of time keeping. Some most prevalent methods are as follows:

Attendance register
Token or disc method
Time-recording clocks
Biometric time clock

PAYROLL DEPARTMENT

The payroll department is concerned with the compensation of the workers. This department
takes data from the time keeping department and computes the salaries of the employees at the
end of every month.

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COST ACCOUNTING DEPARTMENT

Cost accounting department is the final destination of the all types of costs related to labour be it
direct cost or indirect cost. For the purpose of collecting the data it makes use of clock cards,
daily or weekly time sheets, payroll sheets etc.

The cost accounting department collates, analyse and present a report reflecting the true picture
of direct labour cost and indirect labour cost in front of management to take decision.

TREATMENT OF IDLE TIME, HOLIDAY PAY, OVERTIME ETC. IN COST

ACCOUNTS

Idle Time: wastage of time during working hours is considered as idle time. Idle time may arise
due to normal and abnormal reasons. Idle time affects the productivity of the labour. For
controlling the cost of labour reduction in idle time is essential. The reasons behind the idle time
must be identified and then steps should betaken to control them.

Normal Reasons of Idle TimeIt refers that any loss of time is inherent in every situation which
cannot be avoided. Any cost which is associated with the normal idle time mostly fixed in nature.
The normal idle time arises due to the following reasons:

Time taken for personal affairs.

Time taken for lunch tea breaks.
Time taken for obtaining work.
Time taken by the workers to walk between factory gate and place of work.

Abnormal Reasons of Idle Timeit generally occurs because of shortage of raw material,
machine break-down, lock-out, strikes etc. Abnormal idle time can be reduced and avoided by
maintaining the operational efficiency in the organisation. Following are the major reasons of
abnormal idle time:

Improper planning.
Lack of planning and co-ordination.
Power failure.
Time lost due to delayed instructions.
Time lost due to inefficiency of workers.
Time lost due to non-availability of raw materials, spare parts, tools etc.
Time lost due to strikes, lock outs and lay-off.

Accounting Treatment:

Cost for normal reasons should be segregated under a separated standing order number
and charged as an item of factory overhead.

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