Cost

Accounting
UNIT-
1
Unit - 1

Introduction and Difference between -

Financial, Cost And Management
1.1 Accounting
1.2Objectives and Scope of Cost Accounting
1.3Cost Classification and Elements of Cost
1.4Cost Unit and Cost Centre
1.5Meaning of Material Control
1.6Steps of Material Control
1.7Techniques of Material Control
1.8Valuation of Inventory
1.1

I n t r o d u c t i o n a n d D i ff e r e n c e
b e twe e n F in an cia l, Cost And
Management Acco unting
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
 Evolution of Cost
Accounting
 Cost Accounting is a recent development in the accounting
world.
 Since the beginning of the 20th Century and particularly
during and after the First World War (1914-1918), the
industrialist become more and more cost-conscious –
because of growing competition between manufactures
and increase of governmental control over pricing, and the
pricing was based on “cost plus” system.
 During world war II many governments came out with the
legislations which had the effect of placing almost a
blanket control over pricing.
Cont‟d
…
 Then, it become necessary for the manufacturers
to control costs and trace the cost of each
product.
 Financial Accounting failed in achieving these
objectives.
 It, therefore, made the accountant to think and a
new technique of accounting known as Cost
Accounting developed.
 Today, it has assumed so much of importance that if
an industrial concern does not have an efficient
costing system, it's survival may become difficult.
Introductio
n

Accountin
g

Financial Cost Manageme

Accountin Accountin nt
g g Accounting
 Financial
Accounting
Financial accounting is mainly concerned with the recording business
transactions in the books of accounts for the purpose of presenting final
accounts.

• The information supplied is summarized in following two statements at the

end of accounting period.

• a) Profit and Loss Account showing the net profit or los during the year.

• b) Balance Sheet showing the financial position of the firm at a point of

time.

The objective of financial accounting is to provide information to the external

parties such as shareholders, creditors, employees, governmental agencies etc.
 Cost
Accounting
Cost Accounting is a branch of accounting which specializes in providing
information about the detailed cost of products or services being supplied by
the organisation.

• It has primarily developed to meet the needs of the management . The

Financial reports provides only limited information but modern
management needs much more detailed cost information for efficient
performance.

Cost Accounting is mainly for internal users i.e. management

 Management
Accounting
It is a broad term and is concerned with all such accounting
information that is useful to management for activities such as
decision making, planning and controlling.

• Any form of accounting which enables a business to be

conducted more efficiently may be regarded as management
accounting.
Relationship between Cost, financial and
Management Accounting

• Preparing Profit and

Financial
Accounti
Loss Account and
n g Balance Sheet

Cost • Analyzing cost for control

Accounti and maximizing efficiency
n g

Manage • Assisting management for

m ent planning, decision making and
Accountin
g control
Cost Accounting and Financial
Accounting
- Suppose
 Comparison
a company is manufacturing three products
– X, Y and Z. Under Financial Accounting and Cost
Accounting, the following types of Statements are
prepared.
 Under Financial Accounting – A profit and Loss

Account is prepared to compute profit as shown

below –
Materials 75000 Sales 150000
Wages 20000
Other Expenses 25000
Profit 30000
150000 150000
 Cont‟d…
.
 This statement shows that total profit is ₹30000, but
it does not disclose the details of profit/loss of each
products X, Y and Z in the total profit. This is
revealed by cost accounting. As shown in the table
below – Statement of Cost and Profit
Total Product X Product Y Product Z
Material 75000 40000 12000 23000
Wages 20000 10000 5000 5000
Other Expenses 25000 20000 3000 2000
Total Cost 120000 70000 20000 30000
Sales 150000 96000 28000 26000
Profit/Loss 30000 26000 8000 (4000)
Cont‟d
…
 The above detailed statement prepared under Cost
Accounting shows that in the total profit of ₹30000,
Product X contributed ₹26000, Product Y ₹8000 and
Product Z gave a loss of ₹ 4000.
 Difference Between Management and
Cost Accounting
Basis Cost Accounting
1. Scope Limited to providing cost
information for managerial
use.
2. Emphasis On cost ascertainment and cost
control to ensure maximum
profit.
3. Evolution Due to limitations of
financial accounting
4. Statutory Maintenance of cost accounts has
Requirement been made compulsory in selected
industries as notified by Govt.
from time to time.
Management Accounting
Broader than that of Cost Accounting as it
provides all types of information i.e. cost
as well as financial information for
managerial use.
On planning, controlling and decision
making to maximize profit.
Due to limitation of cost accounting.
Management accounting is an extension
of managerial aspect of cost accounting.
Management accounting is purely voluntary
and its use depends upon its utility to
management.
 Cont‟d…
…
Basis Cost Accounting Management Accounting

5. Database Based on data derived from Based on data derived from

financial accounts. cost accounting, financial
accounting and other
sources.

6. Installation Can be installed without Cannot be installed without

management accounting a proper system of cost
accounting.

7. Status in organisation In the organisational set- Management accountant is

up, cost accountant is generally placed at a
placed at lower level in higher level of hierarchy
the hierarchy than the thanthe cost accountant.
management accountant.
 Difference Between Financial and
Basis
Cost Accounting
Financial Accounting Cost Accounting
1. Purpose To prepare P&L A/c and Balance To provide detailed cost information
sheet for reporting to owners and to management. i.e. internal users.
other outside users, i.e. external
users.
2. Statutory These accounts have to be prepared Companies Act has made it
Requirem according to the legal requirements compulsory for certain industries to
ent of the Companies Act and Income maintain Cost accounts ,otherwise it
tax Act is voluntary
3. Analysis of It reveals the profit or loss for the It shows the detailed cost and
Cost and organisation as a whole for a profit data for each product,
profit particular period but does not show Process and department etc.
in detail the cost and Profit for
individual products, processes and
departments.
4. Control aspect On recording of financial transactions It provide for detailed system on
not on the control aspects. control with various techniques
like standard and variance
costing.
 Cont‟d…
Basis
… Financial accounting Cost Accounting
5. Periodicity of Financial reports ( P&L A/c, Cost reporting is a continuous process
reporting Balance Sheet and Cash Flow and may be daily, weekly monthly etc.
)are prepared usually on
annual basis.
6. Types of Prepare general purpose Special purpose statements like
statements statements like P&L A/c Variance report, Idle time report etc.
prepared and Balance Sheet .

7. Format Single uniform format Varied forms of presenting information

of presenting which are tailored to meet the needs
information . of management thus lacks a uniform
format.
 Definition of Cost
Accounting
 According to L.C. Cropper, “ cost accounting means a
specialized application of the general principles of
accounting in order to ascertain the cost of producing
and marketing any unit of manufacture or of carrying
out any particular job or contract.
 CIMA, London defines it as ,” the application of
costing and cost accounting principles, methods and
techniques to the science, art and practice of cost
control and the ascertainment of profitability.”
1.
2

O bj ecti ve s a nd Scope o f Cost

Accoun ting
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
 Objective
s
 Ascertaining cost : The first and foremost objective
of cost accounting is to find out the cost of a
product, process or service.
 Ascertaining Profit – Cost Accounting also aims at
ascertaining the profits of each and every activity. It
produces statements at such intervals as the
management may require.

Cost control and Cost reduction: Cost accounting
aims at improving profitability by controlling and
reducing costs. For this purpose, various specialized
techniques like standard costing, budgetary control,
inventory control etc. are used.
 Cont‟d…
…

Guide to business policy: Cost accounting aims at
serving the needs of the management in conducting
the business with utmost efficiency. Cost data provides
the guidelines for various managerial decisions like
make or buy, selling below cost , shutting down or
operating at loss etc.

Determination of selling price: It provides cost
information based on which selling prices of various
products may be fixed. In period of depression, cost
accounting guides in deciding the extent to which
selling prices may be reduced to meet the situation.
 Cos
t
 Cost may be defined as, “ the amount of
expenditure (actual or notional) incurred or
attributable to a given thing.

 Cost represents the resources that have been or must

be sacrificed to attain a particular objective.
 Cost
Accountancy
 Cost accountancy is a wide term.

It includes and means all the principles, conventions,
techniques and systems which are employed in a
business to plan and control the utilization of resources.
 CIMA, London defines it as ,” the application of costing
and cost accounting principles, methods and
techniques to the science, art and practice of cost
control and the ascertainment of profitability.”
 Scope of Cost
Accounting
 Costing
 Cost Book
keeping
 Cost Control
 Cost Reduction
 Cost Audit
 Cost Analysis
 Costin
g
 It is technique and process of ascertaining costs.

It differs from cost accounting in the sense that cost
accounting provides only the basis and information for
the ascertainment of cost.
 Once the information is made available, the costing
can be carried out arithmetically to calculate the cost.
Cost Book
Keeping
 It involves maintaining complete record of all costs
incurred from their occurrence up to the charging to
final products/services. Such records are
preferably kept on the basis of double entry
system.
 Cost
Control

It includes the comparison of actual cost incurred
with the predetermined standard cost so that the
difference between the two can be analysed and
used for cost control purpose.
 It is exercised by a variety of techniques such as
standard costing, budgetary control and quality
control etc.
 Cost
Reduction

It is a technique used to achieve real and
permanent reduction in the unit cost of the product
without compromising its quality.
 This requires constant research and development in the
areas of product design, production procedures etc.
Cost
Audit

It is the verification of cost accounts and a check
on the adherence on the cost accounting plan.

It involves checking up the accuracy of cost
accounts and verifying whether the principles laid
down have been followed or not.
 Cost
Analysis

Costs recorded in the books are analysed
according to the categories such as direct and indirect
costs, fixed and variable costs etc.
1.
3

Cost C l a s s i f i c a t i o n and Elements o f

Cost
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
Elements of
Cost
Cos
t

Materia Labou Expense

l r s

Direc Indirect Direc Indirect Direc Indirect

t t t
 Direct Material
Cost
Direct material cost is the cost of all materials which
becomes an integral part of the finished product and
which can be easily identified with and allocated to
cost centres.
Direct material generally forms the part of final product.
(cotton used in textile mill.)
Sometimes the material forms the part of the final
product but yet it is not treated as direct material.
( nuts and bolts)
Examples : Clay in bricks, Cloth in textile etc.
Indirect Material
Cost

Indirect material cost is the cost of all material
which is used for purpose ancillary to the business and
which cannot be easily identified with individual cost
units.

Example Office stationery, nuts and bolts, small tools
and oils etc.
 Direct labour
Cost

Direct labour cost consists of wages paid to the
workers directly engaged in converting raw material
into finished goods.

These costs can be conveniently indentified with a
particular product, job or process.
 Wages paid to a machine operator or a carpenter are
examples.
 Indirect Labour
Cost

Indirect labour is not directly engaged in the
production operations but only to help in the
production operations.
 Foreman‟s salary and peon
 Direct
Expense

These are those expenses which can be identified
with and allocated to the cost centres.
 Hiring of special plant for a particular job
 Cost of patent right
 Royalty paid in mining
 Indirect
Expenses

These are the expenses whichcannot be
directly, conveniently and wholly allocated to cost
centres.
 Rent and rates
 Depreciation
 Repairs
 Overhea
d

This is the aggregate of indirect
material,indirect labour, indirect expenses.

 Thus, Overhead= indirect material + indirect labour

+ indirect expenses
 Cont‟d
…..
Overhea
d

Office and
Productio Administra Selling and
n ti ve
Overhea Overhead Distributio
d n
Overhead

Indirect Indire
Indire materi ct Indirect
ct Indirect labour expens
Indirect Expens al
Materi labour Salary e
e Packing
al Wages of sales Adverti
Factory
ren materi manger
Coal, of al sing
factory t
oil
sweeper Indirect Indirect
Materi Indire expens
al ct e
labour
Postage, Salary of Rent of
Sweepin office office
g Brush staff buildin
g
 COST
SHEET
PARTICULARS TOTAL COST
COST PER
₹ UNIT
₹
Direct Material
+ Direct Labour
+ Direct Expense
= Prime Cost /Direct Cost
+ Factory Overhead
= Works Cost/ Factory cost
+ Office and administration overhead
= Cost of Production
+ Selling and Distribution overhead
= Cost of Sales
PROFIT
SALES
 Cost
Classification
 Direct and Indirect
Cost DirectCost– those which can be easily
costs conveniently a and or
identified with product other cost
centers.
Indirect Cost – those costs which cannot be easily and
conveniently identified with a product or other cost
centers.
 Cont‟d…
…
Fixed and Variable cost

 Fixed Cost – these costs remain constant in “total” amount

over a specific range of activity for a specified period of
time, i.e. do not increase or decrease with the level of
output.
Example : Building rent

 Variable Cost – these costs tends to vary in direct

proportion to the volume of output.
Example : cost of raw material
 Cont‟d
…
 Semi Variable or semi fixed cost:
These costs include both a fixedand a
variable component, i.e. partly fixed and partly
variable.

They often has a fixed element below which the cost

will not fall at any level of output.

Example- Telephone bill

 Cont‟d…
…
 Product cost and Period cost
Product Cost : these are those costs which are necessary
for production and will not be incurred if there is no
production. They are attached or absorbed by units
produced.

Period Cost: these are those costs which are not

necessary for production and are charged to the Profit
& Loss Account. Such costs are incurred for a time
period. Showroom rent etc.
 Cont‟d…
…
 Controllable and Uncontrollable cost:
Controllable cost- these are those costs which may be
directly regulated at a given level of management
authority. They are controlled by head of department.
Cost of raw material may be controlled by purchases
in larger quantities.

Uncontrollable Cost – these are those cost which cannot

be influenced by the action of a specified member of
an enterprise. Eg. Factory rent.
 Cont‟d
…..
 Historical and pre-determined cost:
Historical costs: these are those costs which can be
ascertained only after they are incurred. They are
nothing but actual cost.

Pre-determined costs: these can be ascertained in

advance of production on the basis of a specification
of all the factors affecting cost.
 Cont‟d…
.
 Relevant and irrelevant Cost:
Relevant costs are those costs whose magnitude will be
affected by a decision being made.
Irrelevant costs are those which would be not
be affected by the decision.
Example: Management is considering
closing down a unprofitable unit.
Relevant cost- Wages of workers of that
unit. Irrelevant cost- Prepaid rent of that
unit.
 Cont‟d
…..
 Sunk Cost:
It is an expenditure made in the past that cannot be
changed and over which management has no longer
control.
These costs are not relevant for decision- making about
the future.
Example- The book value of an asset currently being
used is not relevant in making the decision to replace it.
1.
4

Cost C e n t r e and c o s t
Unit
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
 Cost
Centre

For the purpose of ascertaining costs, the whole
organisation is divided into small parts or sections.


Each small section is treated as a cost centre of
which the cost is ascertained.


Cost centre is defined as “location, person, or item
of equipment(or group of these) for which the costs
may be ascertained and used for the purpose of
control.”
 Cost
Unit

It is defined as a “unit of product or service
in relation to which the costs are ascertained.”

It becomes necessary to select a
unit with which expenditure may be identified.

Example
Industry Cost unit
Sugar Tonne
Bricks 1000 bricks
Hospital bed per day
Advantages of Cost
Accounting
 Reveals profitable and unprofitable
activities
 Helps in cost control
 Helps in cost reduction
 Helps in decision making
 Guides in fixing selling price
 Checks the accuracy of financial accounts
 Prevents frauds and manipulation( Cost
Audit)
 Disadvantages of Cost
Accounting
The system is more complex:
Cost accounting needs to identify the different types of expenses
and allocation of expenses is considered as a complicated system
of accounting. It needs different forms and formulas to collect the
data and preparing the reports. More complex and complicated
system of cost accounting is one of the limitation facing by the cost
accounting.
It is expensive:
In installing and maintaining cost accounting system requires more
man power and resources. More analysis, allocation and
absorption of overheads requires considerable amount of
additional work. If the expenses incurred in ascertaining the cost is
more than what is derived from it, then the process of cost
accounting is meaningless.
 Cont‟d…
.
 Inapplicability of costing method and technique.
Technique and methods of cost accounting differ from
organization to organization. It depend on the nature of
business and the type of service/product manufactured
by the firm. So inapplicability of same costing method
and technique is the one of the main limitation of cost
accounting.

 Use of Secondary Data: Cost accounting depends on

financial statements for a lot of information. Any errors
or short coming in the information will affect the results.
1.
5

Meaning o f M a t e r i a l C o n t r o l
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
Meaning of
Material

Material is any substance that is used for the
purpose of production of goods or services.

 Material can be classifiedinto „direct‟

material and
„indirect‟ material.
 Direct
Material

Direct Material Cost is the cost of material which can be
directly allocated to a cost centre or a cost object in an
economically feasible way.


Direct material include not only the raw materials entering at
the start of the production but all of the following-

1. Component parts used in a product, e.g. tyres and

tubes in a car
2. Any material used in the production but wholly consumed
in the production process, e.g. Fertilizers used in growing
plant.
3. Any primary packing material, i.e. any container sold with
the final product, e.g. cans for tinned food and drink.
 Indirect

Material
Indirect materials are thosewhich cannot be
easily identified with a particular cost centre or
cost object.
 Example – coal, grease and oil, soap and
sandpaper.
Material
Control
Meaning-
 Material or Inventorycontrol may be defined
as
„systematic control and regulation of purchase, storage
and usage of materials in such a way so as to maintain
an even flow of production, at the same time avoiding
excessive investment in inventories.

 Efficient material control cuts outlosses and wastes of

materials that otherwise would pass unnoticed.‟
 Significance of Material
Control
 Materials form an important part of the cost of a
product and, therefore, proper control over material
is necessary form the time orders are placed with
the supplier till they are actually consumed in plant
and office operation, or have been sold as
merchandise.
 An efficient system of materials control will lead to
a significant reduction in production cost.
 Control over materials is also necessary to assure
a steady supply of each item of material.
Objectives of Material
Control
 No under-stocking – Under-stocking inevitably leads to
materials running out of stock at some time. Shortage of
material may arise at a time when they are urgently
needed and production may then be held up. The delay
or stoppage in production due to non-availability of
materials is very costly and results in loss of profits.
 No over-stocking – Investment in material may be kept as
low as possible considering the production requirements
and the financial resources of the business. Over-stocking
of materials locks up capital and causes high storage
costs, thereby resulting in adverse effect on profits.
Cont‟d…
.
 Economy in purchasing – The purchasing of material is
highly specialized function. By purchasing material at
the most favorable prices, the purchases is able to
make a valuable contribution to the reduction in cost.
 Proper quality – While purchasing materials, due
consideration should be given to the quality. For each type
of product, there is a particular type of quality of
material which is needed and that quality alone should
be purchased.
 Minimum wastage – Losses of material occur due to
deterioration, obsolesce, pilferage, theft and evaporation.
All efforts should be made to keep those losses at
minimum level.
Cont‟d…
.
 Information about material – There should be a
system to complete and up-to-date accounting
information about the availability of materials.
1.
6

Steps I n vo l v e d in M a t e r i a l C o n t r o l
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
 Steps involved in Material
Control
1. Purchasing of materials
2. Receiving of materials
3. Inspection of materials
4. Storage of materials
5. Issuing of material
6. Maintenance of inventory
record
7. Stock audit
 1. Purchasing of

material
Purchasing should be centralized i.e., all purchases
should be done by the Purchasing Department except for
small purchases which may be done by departmental
managers.

Full co-operation between Purchasing Department and
other departments is necessary.

Close liaison is a must between the Purchasing and the
Accounts departments, as purchasing involves financial
liability.
 The purchase manager should have a good technical
knowledge of the industry.
 A proper purchase procedure should be followed.
 Purchasing

Procedure
Purchasing requisition-
 The initiation of purchase begins with the receipts of a
purchase requisition by the purchasing department.

The requisition contains particulars regarding
quantity, the quality or material specifications, and
the date by which purchase of materials is required.
 Cont‟d…
.
 Inviting Quotations:
 On receipts of Purchase Requisition, the Purchase
Department would invite tenders or quotations for
supply of goods.
 Cont‟d

…
Purchase Order:

The purchase order is prepared by the purchasing
department.

It is a written authorisation to the vendor to supply a
specialized quantity and quality of materials at the
stipulated terms, and at the time and place
mentioned.
 2. Receiving of
Material

The work of unpacking the goods and their
verification is performed by the Receiving
Department.

The receiving clerks verifies the content of the
package with the consignment quantity received by
him, and the condition of goods, in the consignment
notes.
 3. Inspection of
materials

The responsibility of verifying the weight, count or
measurement is that of receiving department, but the
responsibility to see that goods have been received
according to purchase order specifications, is that of the
inspection department.
 It may subject samples to laboratory tests, if
necessary.
 4. Storage of
Material

The function of storage of material
is performed by storekeeper.

His duties include accepting, identifying, classifying
and proper placing of materials.
 Efficient storage requires-
i. Checking of material
ii. Classification and codification of
iii material Bins and racks
.
 5. Issuing of
Material
Material Requisition-

Material should be issued by the store-keeper only
on presentation of a duly authorization “Materials
Requisition Note”.
 It has been defined as “a document which authorises

and records the issue of material for use.”

 Cont‟d…
.
Bills of materials:

It is specification of materials needed for a job or
unit of production.

It serves as a standard list of materials required for
a particular job, process.
 Cont‟d…
…
Materials Returned Note-

Materialssupplied to a job maybe in excess
of its requirement or may be defective.

In such a case the concerned will return the materials
to the store with a „Materials Returned Note‟.
 Cont‟d…
.
Materials Transfer Note-

When materials are transferred from one job to
the stores and from there to the another store a
Materials Transfer Note is required.
 6.Maintenance of Inventory
Record

Twosets of records for material
received, issued or transferred are generally
maintained.
 They are –
 By the Storekeeper in the stores.
[Bin cards, stores material control record]
 By the costing
office. [Stores
Ledger]
 Bin
Card

Bin means a rack, container or space where goods
are kept.

The store is fitted with serially numbered bins, each
meant for a particular type of material.

A card is placed outside each bin and, whenever the
materials are issued or received a narration is made on
the card.
Stores material control
record

It is usually an alternative to Bin card. Disadvantage
of Bin card is that storekeeper does not have all
details of material required close at hand . He will
have to go to the appropriate bin to find out the
details of the material.

In case of Stores Material Control Record all details
are available to storekeeper at close hand.

It is a card life or loose leaflet file where
storekeeper notes information such as quantities
ordered, probable requirement etc.
 Stores
Ledger

The cost office maintains a stores ledger in which a
separate account is opened for each kind of materials
and spare parts stocked in store.

Entries made in the store ledger are similar to those
on Bin card.
 Store staff should not have any connection in writing up
of Stores Ledger otherwise it will fail to impose an
internal check upon the stores staff to maintain
accurate store record.
 Inventory

Systems
Periodic Inventory System-
In this system the quantity and value of inventory is found
only at the end of accounting period only after having
physical verification of units in hand. The system does not
provide the information regarding the quantity and value
of material in hand on a continuous basis.
 Perpetual Inventory System –

It is the method of recording stores balances after

each receipt and issue to facilitate regular checking
and obviate closing down for stock – taking.
 Cont‟d
…
Perpetual Inventory
In this system, records are maintained
continuously which reflects the physical
movements of stock and current
balance after every receipt and issue.
Production is not stopped for stock
taking.
It is relatively an expensive method
This inventory system is appropriate for
large enterprises.
Periodic Inventory System
In this system, stock taking is done only at
the end of a specified period, generally
at the end of an accounting period.
Therefore, data about current balance,
issue and receipts of raw material can be
known only at the end of accounting
period.
Production is suspended for a few days to
facilitate stock taking.
It is less costly method
This system is suitable for small
organisation.
 7. Stock
Audit

It implies the verification of stock with
the inventory records
 Physical verification of stock may be-

Periodic – When physical verification is
done periodically (half- yearly or yearly)

Continuous – In this continuous checking is
done by taking different sections of stores in
rotation.
1.
7

Techniques o f M a t e r i a l C o n t r o l
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
 TECHNIQUES OF MATERIAL
CONTROL
 Stock
levels
 ABC
 JIT
 EOQ
 FSND
 VED
1. STOCK
LEVELS

In order to guard against under-stocking and
over- stocking, companies adopt a significant
approach of fixing stock levels.
 These are-

1. Maximum Level

2. Minimum Level

3. Reorder Level

4. Reorder Quantity
 Cont‟d
…..
 Factors that influence stock levels are-
1. Anticipated rate of consumption
2. Amount of Working Capital

3. Availability of storage space and its cost

4. Procurement costs

5. Reliability of suppliers

6. Risk of loss due to

a) Obsolescence b) Deterioration c) evaporation d)

fall in market place
 Reorder

Level
It is that level of material at which purchase
requisition is initiated for fresh supplies.
 This level is fixed somewhere above minimum level.


Formula = Maximum
consumption * Maximum reorder
period
 Factors

a)Lead time b) Rate of consumption of material

c) Minimum level d) Variation in Lead time
 Maximum
Level

This is the level above which the stocks should
not normally be allowed to rise.
 Formula =
Reorder level + Reorder Quantity – ( Minimum Consumption *
Minimum delivery period)

Its purpose is to prevent unnecessary
blockage of funds in stores.
 Factors a) Rate of consumption of material
b) Storage space and costs c) availability of
funds d)Reorder quantity e) Seasonal
consideration
 Minimum
level

It is that level below which stock is generally
not allowed to fall.

This is essentially a safety stock and is not
generally touched.

Formula = Reorder level – (Normal
Consumption * Normal delivery period)

Factors a) rate of consumption b) time required
under for fresh supplies under priority conditions.
Average Stock
Level
Formula = ( Minimum level + Maximum level)/2

Danger
Level

Sometimes purchased materials are not
received in time and stock levels goes below the
minimum level.

Danger level is a level at which normal issues
are stopped and materials are issued only for
important jobs only.

When Danger Level is reached, urgent
action is required for replenishment of
material.
2. EOQ (Reorder
Quantity)

It is also known as Economic Order Quantity as
it represents the quantity which is most
economical to order.
 It is that quantity for which order is placed when
the stock reaches reorder level.
 Cont‟d…
.
The two types are taken into consideration
while calculating EOQ:
 Ordering Cost: This is the cost of placing an

order with the supplier.

 Cost of carrying stock: It is the cost of keeping item

in stock. It includes interest on investment, store

keeping cost, insurance premium etc. . The larger the
volume of inventory, the higher will be the carrying
cost vice versa.
 Cont‟d…
.
 Formula
EOQ= √(2 U*P)/S
where
U= Quantity required in a
year P= Ordering cost per
order
S= Carrying cost per unit per
annum
 Question
1
Two materials A and B are used as
follows-
Minimum usage 50 units per week
Maximum usage 150 units per week
Normal usage 100 units per
Reorder quantity week
Delivery A- 600 units B-
period 1000 units
A- 4 to 6 weeks
B- 2 to 4 weeks
Calculate various stock
levels.
 Question
2
The annual demand for a product is 6400 units.
Inventory carrying cost is ₹1.50 per unit p.a. . If
the cost of procurement of order is ₹75,
determine:
a) EOQ

b) No. of orders per year

c) Time between two consecutive orders

Practice
Question 1
The following particulars are
available
Cost of placing an order ₹100
Annual carrying cost per ₹15
unit Normal Usage 50 units per
Minimum usage week
Maximum 25 units per week
usage 75 units per
Calculate - a) Re-order Quantityweek
Reorder period b) Re-order Level c)
Minimum Level d) Maximum Level e)6Average
4 to weeks stock level
(52 weeks in a year)
 Practice Question
2
In a manufacturing concern, a material is used as follows
– Maximum consumption – 12000 units per week
Minimum consumption – 4000 units per
week Normal consumption – 8000 units per
week Reorder quantity – 48000 units
Time required for delivery - 4 to 6 weeks
Calculate – (a)Reorder level, (b)Minimum level,
(c) maximum level, (d) Average stock level
Answer - (a) 72000units, (b) 32000 units (c)
104000 units
(d) 68000 units
 Practice Question
3
The average annual consumption of a material is
18250 units at a price of ₹36.50 per unit. The storage
cost is 20% on an average inventory and the cost of
placing an order is ₹50. How much quantity is to be
purchased at
a time?
Ans – 500 units
 3. ABC Technique (Selective
Control)

ABC technique is a value based system of
material control .

In this technique, materials are analysed
according to their value so that the costly and more
valuable materials are given greater attention and
care.

All items are classified according to their value-
high, medium and low values, which are known as A,B
and C items respectively.
 Cont‟d…

. “A” items – These are high value items which may
consists of only a small percentage of the total items
handled. On account of their high cost, these materials
should be under the tightest control and the
responsibility of the most experienced personnel.

“B” items – These are medium value materials which
should be under the normal control procedures.
 Cont‟d…
.

“C” Items – These are low value materials which may
represent a very large number of items. These materials
should be under simple and economical method of
control.


The point of classifying stock into A, B and C
categories is to ensure that material management focuses
on A items where sophisticated controls should be
installed.


B items may be given less attention and C items the
 Cont‟d
…..
CATEGORY % OF % OF TYPE OF
TOTAL TOTAL CONTR
VALUE QUANTITY OL
A 70 10 Strict control
B 25 30 Moderate control
C 5 60 Loose control
 Cont‟d…
.
Advantages of ABC Technique –

Close and stricter control on items which
represents large amounts of capital invested.
 Economy in carrying cost.

It helps in maintaining enough stock for “C”
category items.

Selective control in maintaining high stock
turnover rate.
 Investment in stock is regulated.
 Cont‟d…
.
Limitation

It does not lay stress on items which are less costly
but may be vital.
 Just In Time

(JITJIT)is a purchasing and inventory control method in
which materials are obtained just – in - time for
production to provide finished goods just in time for
sale.
 There are aspects of JIT

1. JIT purchasing

2. JIT production

According to CIMA, London JIT purchasing is
„matching receipts of materials closely with usage so
that raw material inventory is reduced closed to zero
level‟.
Cont‟d…
.

JIT purchasing requires better coordination with the
suppliers so that the materials arrive immediately
prior to their use.

Firms‟ using JIT maintain long term contracts with
them to enable vendors to plan their annual
production.

JIT is a demand- pull system. Demand for
customer output triggers production.
Cont‟d…
.
JIT aims to achieve the following
objectives
 Zero inventory

 Zero breakdown

 100% on time delivery service

 Elimination of non- value added

activities
 Zero defects
Cont‟d…
.

JIT focuses on frequent deliveries of material
in smaller quantities.

It results in enormous savings in storage costs,
material handling costs, spoilage etc.
 JIT production and JIT
purchasing reduces inventory and the costs
associated with carrying the inventory.
 It is required that the companies using JIT
must eliminate all the sources of failure in the
system.
 FSND

Analysis
FSND analysis shows the duration of inventory in
an organisation analysing their moving position.

F stands for fast moving items being consumed in
a short period of time.
 S stands for slow moving items.
 N indicates normal moving items
 D stands for dead stock having no further demand.
 Cont‟d…
.

To conduct this analysis, the last date of receipt or
the last date of issue, whichever is later, is taken into
account and the period, usually in terms of months, that
has been elapsed sincethe last movement is recorded.

 Such analysis helps to identify –

 Active items which require to be reviewed regularly

Surplus items whose stocks are higher than their rate
of consumption
 Non- moving items which are not being consumed.
VED
analysis

ABC analysis does not address the issue of what
happens if we do not have materials when required.
 This approach to inventory requires to group all the
items into three categories based on opportunity cost
of shortages.

On the basis of criticality of items, materials are
classified as V(vital), E(essential), and D(desirable).
 Cont‟d…
…
 V= Vital items, must have them in stock when needed.
V items have extremely high opportunity cost of
shortage, almost catastrophic impact result in complete
stoppage of production, delayed projects, and failed
missions.

 E= Essential items, should have them in stock.

E category items have significant opportunity cost of
shortage but it is not that high or catastrophic as V
category. For them risk of shortage is tolerable.
 Cont‟d…
…
 D= Desirable items, can have them in stock.
In D category , the shortage may be quite low, and
hence a still higher risk of shortage can be tolerated.
 Exampl
e
In the inventory control of medicines in a hospital or a
chemist shop, medicines which are lifesaving will come
under V category because of their non-availability
could lead to loss of human life. E category medicines
are those which are essential, but some degree of
backlogging is feasible, and delay will not lead loss of
life or alternate substitute may be available. D
category medicines such as vitamins, food supplements
etc., are those where service could be low.
1.
8

Va l u a t i o n o f I n v e n t o r y
 SuggestedReadings:

1. Author – M N Arora
Title of Book – Cost Accounting Principles
and Practice
Publisher – Vikas Publishing House
2. Author – S N Maheshwari & S N Mittal
Title of Book – Cost Accounting: Theory and
Problem
Publisher – Shree Mahavir Book Depot
 Valuation of
Inventory

Materials are issued to different jobs or work orders
from the stores.

These jobs or work orders are charged with the
value of materials issued to them.

However, the stock of materials consists of different
consignments received at different dates and prices.
 Therefore, it becomes necessary to decide about the
price which is to be charged from a particular job when
materials are issued to it.
 Cont‟d
…..
The various methods of valuing material issue are
–
 FIFO

 LIFO

 Weighted Average
 FIF
O

Under this method it is assumed that the materials
first received are first to be issued.

Thus, units issued are priced at the oldest cost price
on the stock ledger sheets.
 It uses the prices of the first batch of the materials
purchased for all issues until all units from this batch
have been issued.
 After the first batch is fully issued, the price of still next
batch is used for pricing and so on.
 LIF
O
 This method operates in just the reverse order of FIFO
method.
 It is based on the assumption that the last materials
purchased are the first materials to be issued.
 Thus, prices of last batch of the materials purchased is
used first for all issues until all units have been issued,
after which the price of the previous batch of materials
purchased is used.
Weighted Average
Method
 Under this method the issue price is calculated by dividing
the value of materials in hand by the number of units in
hand. The average price to be charged to issues will
continue to be the same until a new purchase is made
which will necessitate computation of new average.
 It method reduces the number of calculations to be made
as the old average will continue till fresh supply of
material is obtained.
 But under this system on account of approximation being
used while calculating the average price of profit or loss
on issue of material may arise.
Practice Question
1
 Practice Question
2
The following is the record of receipt of certain material s
during the month of Feb. 2000. Prepare stores ledger on
FIFO , LIFO and Weighted Average Method.
Feb. 1 – received 400 units @ ₹10 per unit
Feb. 4 – received 300 units @ ₹11 per unit
Feb. 16 – received 200 units @ ₹12 per
unit Feb. 25 – received 400 units @ ₹13
per unit During Feb. the following issues
were made- Feb. 10 – Issued 200 units
Feb. 15 – Issued 100 units
Feb. 17 – Issued 200 units
Feb. 20 – Issued 200 units
Feb. 26 – Issued 100 units