Costing Materials

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2Materials

Question 1

List five types of inefficiency in the use of materials that may bediscovered as the result of investigating material quantity variances.What measures may be taken in each such situation to prevent theirrecurrence?

Answer

The five types of inefficiency in the use of materials that may bediscovered as a result of investigating materials quantity variancesare as follows:

1. Purchase of inferior quality of materials.

2. Inefficient labour force leading to excessive utilisation ofmaterials.

3. Defective machines, tools and equipments and bad or impropermaintenance leading to breakdowns resulting in excessive usageof materials.

4. Inaccurate technical specifications and slackness in inspectionmay cause more rejections, resulting in greater requirement ofmaterials for rectification of defects.

5. Faulty material processing.

The measures which may be taken in each of the abovesituations to prevent their recurrence in future are as below:

1. To ensure the purchase of proper quality of material, each lot ofmaterial purchased should be inspected in accordance with theterms and conditions of purchase before they are accepted andissued for production. The extent of inspection may depend onthe circumstances. For instance, when materials are of smallvalue or where the quality of raw materials does not appreciablyaffect the final product, the inspection may not be very rigid. In


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such a case, inspection may be carried out by taking randomsamples. However, for materials of vital importance like rawmaterials for explosive factories or for pharmaceutical concernswhere material cost is high, a rigid or strict inspection will benecessary.

2. Labour inefficiency can be reduced by adopting followingmeasures:

(a) Imparting on-the-job training to workers.

(b) Supervising the workers while performing the jobs.

(c) Evaluating workers performance.

(d) Incorporating incentive schemes for workers.

(e) Reducing labour turnover ratio.

3. The wastage of material can also be reduced by properlymaintaining machines, tools and other equipment. The concernshould adopt a policy of preventive maintenance. The use ofsuch a policy will reduce machine down time and over-consumption of materials. Besides this, workers must beeducated to realise fully the importance of tools and equipmentin their day-to-day work.

4. A reduction in the number of defective units, in this case mayautomatically bring down the excessive consumption of materialrequired for rectification of defects. Reduction in the number ofdefectives can be achieved by laying down accurate technicalspecifications, standards for materials and tactfully handling theproblem of slackness.

5. Faulty material processing also results in excess consumption ofmaterial. The supervisors at the shop floor level should educateand guide the workers properly so that they make use of thecorrect procedure laid down for processing raw materials.

Question 2

Many businesses have an unnecessarily large amount of capitallocked up in the raw materials and work-in-progress. Indicatemethods of correcting this position.

Answer

The problem of unnecessary locking up of the funds in rawmaterials and work-in-progress can be solved by adopting thefollowing methods:-

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1. Budgeting materials requirements: To control investment in rawmaterials it is necessary to know in advance about the materialsrequirement during a specific period, usually a year. The exactquantity of materials and the time when they would be requiredcan be known by studying carefully production plans andproduction schedules. Based on this, materials requirementbudget can be prepared. Such a budget will discourage theunnecessary investment in raw materials . This budget may alsobe used as a basis to assess the performance of executives withregard to investment in raw materials.

2. ABC Analysis : The technique of ABC analysis also helps in a big

way in overcoming the problem of unnecessary locking up of thefunds in raw materials. Under this method all the raw materialsare generally classified into three categories A, B & C on thebasis of their use value. The costliest items are placed under ACategory. These items are controlled by top executives whereasB and C category of items may be controlled by middle level andlower level executives respectively. This classification helps inensuring that unnecessary funds are not blocked in rawmaterials particularly in A category items because of their highvalue. In fact, ABC analysis is a method which clearly indicatesthe items of raw materials to be controlled by managers at

different levels. These managers also ensure a proper decisionwith regard to investment in raw materials in respect of theitems falling in their domain.

3. Fixation of raw material levels: To avoid unnecessary locking upof funds in raw materials, it is desirable to fix up various levelslike re-order level, maximum level, minimum level, safety stock,economic order quantity etc. Such levels may be fixed up aftertaking into account the factors like rate of consumption, leadtime, ordering cost, handling cost etc. This method of stockcontrol, besides avoiding unnecessary locking up of capital inraw materials, reduces total inventory costs which include

inventory carrying costs and ordering costs.4. Control over slow-moving and non-moving items: Sometimes,

due to high value of slow moving and non-moving raw materials,it appears that the concern has blocked huge sum of moneyunnecessarily in raw materials. To overcome this problem, it isnecessary to dispose-off as early as possible the non-movingitems or make arrangements for their exchange with the rawmaterials required by the concern. Besides this, no newrequisition should be made for the purchase of slow movingitems, till the existing stock is exhausted. Computation of

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inventory turnover ratio may help in identifying slow movingitems.

5. Variety reduction: Huge investments are sometime made for thepurchase of the same raw material under different brand namesto cater to the needs of different user departments. Significantreduction in investment can be brought about by selecting aparticular brand/variety of raw material suitable for all the userdepartments. Under this method instead of purchasing a numberof brands, say ten brands of the same material, the decision maybe taken to purchase less number of brands, say one or two.Such a decision would minimise unnecessary locking up of funds

in raw materials.

6. Codification of materials: It has been observed that the samematerial used by different departments is also named differentlyby them. Due to this, for the same material, the purchasedepartment places different orders and the stores departmentstores it at different places. Even the accounts for thesematerials are maintained separately. Such a practice results inthe unnecessary locking up of funds. Here the excessiveinvestment in raw materials can be reduced by resorting to thetechnique known as "Codification of materials". Undercodification a code may be assigned to each material. The

assigned code should be used henceforth for requisitioning thematerial from stores by different departments instead of itsname.

7. Control of work-in-progress: The investment in work-in-progressdepends upon the number and sequences of the processes andsub-assemblies and the length of the production cycle. A systemof efficient production planning and scheduling would assist inmaintaining an uninterrupted flow of work and reducing thelength of the production cycle. It will ultimately avoidunnecessary locking up of the funds in WIP inventory.

Question 3Discuss briefly how the following items are to be treated in

costs:-

(i) Carriage inwards raw materials

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(ii) Storage losses

(iii) Cash discount received

(iv) Insurance costs on stocks of raw materials.

Answer

(i) Carriage inwards on raw materials: It represents theexpenditure incurred in bringing raw materials to factory fromoutside. This expense is directly allocated to materials and thusforms a part of the .cost of such materials. When this is notpracticable and allocation to specific items of materials is

difficult, the expense is treated as manufacturing overhead andis charged to cost of production at a predetermined rate. Insome of the undertakings the practice is to charge theseexpenses as a percentage of cost, weight or some other physicalunit of material.

(ii) Storage losses: The losses arising out of storage ofmaterial can be classified into two categories. The treatment oflosses under each category in Cost Accounts is as under:-

(a) Losses due to reasons like evaporation, shrinkage,absorption and moisture, etc. are considered as normallosses. Such losses are absorbed by good production units by

inflating the cost of material issued for production.

(b) Losses due to fire, flood, storm, theft etc. are treated asabnormal losses. If these losses are heavy and are notrecoverable from the insurance authorities, it is preferred tocharge them to Costing Profit and Loss Account.

(iii) Cash discount received: It is an allowance given by thevendor for prompt payment of material price. The opinion amongaccountants about its treatment differs. Two prevalentapproaches for treating the cash discount received are asfollows:-

(a) The cash discount received in the course of materials buyingshould be deducted from the invoice price of the materials.

This way the discount received will reduce the purchaseprice of the materials.

(b) It may be treated as an item of financial nature andtherefore be kept outside the purview of cost accounting.However, it can be dealt in the following manner.

The full invoice price should be charged to the material accountcrediting the suppliers with the net invoice price, and the discount

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earned account with the amount of cash discount received. If theprompt payment could not be made, the discount lost is debited tothe discount lost account. Any difference between the discountearned and discount lost may be treated as an item ofadministrative overhead.

(iv) Insurance costs on stocks of raw materials:The amountpaid as insurance costs (insurance premium) on stocks of rawmaterials is meant for covering the risk which may arise due tofire, theft, riot etc. The insurance cost is apportioned overdifferent materials on the basis of their value. This cost may becharged directly to the cost of material.

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Question 4

Distinguish between spoilage and defectives in a manufacturingcompany. Discuss their treatment in cost accounts and suggest a

procedure for their control.

Answer

Spoilage can be defined as the materials which are badlydamaged in the course of manufacturing operations to the extentthat they cannot be rectified economically and hence taken out ofprocess, to be disposed of in some manner without further

processing. Spoilage may be either normal or abnormal.Defective products are such semi-finished or finished products

produced by a manufacturing unit, which are not in conformity withlaid-down standard or dimensional specifications. Defectivesproduced can be re-worked or reconditioned by the application ofadditional materials, labour and/or processing and brought to thepoint of either standard or sub-standard product. The costs incurredfor reconditioning are known as the "Costs of re-operations of thedefectives". Defective production may be the result of variouscauses such as sub-standard materials, bad-workmanship,carelessness in planning, laxity in inspection etc.

The difference between spoilage and defectives is that whilespoilage cannot be repaired or reconditioned, defectives can berectified and transformed, either back to standard production or toseconds.

Treatment of spoilage and defectives in Cost Accounting: UnderCost Accounts normal spoilage costs (i.e., which is inherent in theoperation) are included in cost either by charging the loss due tospoilage to the production order or charging it to productionoverhead so that it is spread over all products. Any value realisedfrom the sale of spoilage is credited to production order orproduction overhead account, as the case may be. The cost of

abnormal spoilage (i.e. arising out of causes not inherent inmanufacturing process) are charged to the Costing Profit and LossAccount. When spoiled work is the result of rigid specifications thecost of spoiled work is absorbed by good production while the cost ofdisposal is charged to production overheads.

The problem of accounting for defective work is the problem ofaccounting of the costs of rectification or rework.

The possible ways of treatment are as below:

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(i) Defectives that are considered inherent in the process and areidentified as normal can be recovered by using the followingmethods:

(a) Charged to good products: The loss is absorbed by goodunits. This method is used when 'seconds' have a normalvalue and defectives rectified into 'seconds' or 'first' arenormal.

(b) Charged to general overheads : When the defectivescaused in one department are reflected only on furtherprocessing, the rework costs are charged to generaloverheads.

(c) Charged to the departments overheads: If the departmentresponsible for defectives can be identified then therectification costs should be charged to that department.

(d) Charged to Costing Profit and Loss Account: If defectives areabnormal and are due to causes beyond the control oforganisation; the rework cost should be charged to CostingProfit and Loss Accounts.

(ii) Where defectives are easily identifiable with specific jobs the re-work costs are debited to the job.

Procedure for the control of Spoilage and Defectives : To controlspoilage, allowance for a normal spoilage should be fixed up andactual spoilage should be compared with standard set. A systematicprocedure of reporting would help control over spoilage. A spoilagereport (as below) would highlight the normal and abnormal spoilage,the department responsible, the causes of spoilage and thecorrective action taken if any.

Spoilage Report

Units/Deptt. No..............Date...........

Production Order No...........Units

Produced

Unitsspoile

d

Normalspoilage

Abnormalspoilage

Costof

abnormal

spoilage Rs.

Reason for

spoilage

Action

takenQty. % Qty. %

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Control of defectives may cover the following two areas :

(a) Control over defectives produced

(b) Control over reworking costs.

For exercising effective control over defectives produced and thecost of reworking, standards for normal percentage of defectives

and reworking costs should be established.

Actual performance should be compared with the standards set.Defective Work Report (as shown below:) should be fed back to therespective centres of control.

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Qty. Rate Qty. Rate Qty. RateKg. Rs. Kg. Rs. Kg. Rs.

1.6.82 200 5 - - 200 5

2.6.82 300 6 - - 200 5

3.6.82 400 300

100

6

5

300

100

6

6

The advantages of using LIFO are as follows :

(i) The cost of the materials used is nearer to the current marketprice. Thus the cost of goods produced depends upon the trend

of the market price of materials. This enables the matching ofcost of production with current sales revenues.

(ii) Use of LIFO during the period of rising prices does not depictunnecessarily high profit in the income statement; compared tothe first in first out or average methods, the profit shown isrelatively lower, because the cost of production takes intoaccount the rising trend of material prices.

(iii) Under the LIFO method when prices of materials fall, nodoubt profits tend to rise due to lower material cost, yet thefinished product appears to be more competitive and at marketprices.

(iv) Over a period, the use of LIFO helps to iron out thefluctuations in profits.

(v) In a period of inflation, LIFO will tend to show the correct profitand thus avoid paying unduly high taxes to some extent.

The limitations of the LIFO system :

(1) Calculations under LIFO system become complicated andcumbersome when frequent purchases are made at highlyfluctuating rates.

(2) Costs of different similar batches of production carried on at the

same time may differ a great deal.(3) In times of falling prices, there will be need for writing off stock

values considerably to stick to the principle of stock valuation i.eat cost or the market price whichever is lower.

(4) This method of valuation is not acceptable to the Income TaxAuthorities.

Question 6

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Define (i) Replacement Price and (ii) Standard Price. Discuss theobjectives of these methods of pricing of materials and state thecircumstances in which they are used.

Answer

(i) Replacement Price is defined as the price at which it is possibleto purchase an item, identical to that which is*being replaced orrevalued.

(ii) A Standard Price may be defined as a predetermined price fixedfor a specified period on the basis of all factors which may affectfuture price.

Under Replacement Price method, materials issued are valued atthe replacement costs of the items. This method pre-supposes thedetermination of the replacement cost of the materials at the timeof each issue, viz., the cost at which identical materials could becurrently purchased. The product cost under this method is atcurrent market price which is the main objective of the replacementprice method.

Replacement Price method is used to value material issues inperiods of rising prices because the cost of material considered incost of production would be able to replace the materials at the

increased price. This method is used to find the true cost ofproduction

The fixation of Standard Price takes into account the quantity ofmaterials to be purchased, possibility of price fluctuations, etc. TheStandard Price is used for comparison with actual prices from periodto period and to measure the efficiency of the purchase of materials.

This is used in conjunction with Standard Costing System for controlpurposes and is a tool to the management if fluctuations in pricesare not violent.

Question 7

Explain the distinction between waste and scrap in themanufacturing process. Discuss their treatment in cost accounts andsuggest a procedure for control.

Answer:

Waste : It represents that portion of basic raw materials, which iseither lost or which evaporates or shrinks during a manufacturingprocess. It may be visible or invisible. But it has no recovery value.

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Scrap : The incidental residue arising from the manufacturingoperations, small in quantity and .low in value, recoverable withoutfurther processing.

From the definitions of waste and scrap stated above it is quiteapparent that waste cannot be realised whereas scrap can be. Scrapis always visible whereas waste may or may not be.

Waste can be differentiated as normal and abnormal. Normalwaste is absorbed in the cost of net output, whereas abnormal wasteis transferred to the Costing Profit and Loss Account.

For effective control of waste, normal allowances for yield and

waste should be made from past experience, technical factors andspecial features of the material process and product. Actual yieldand waste should be compared with anticipated figures andappropriate actions should be taken where necessary. Responsibilityshould be fixed on purchasing, storage, maintenance, productionand inspection staff to maintain quality of the materials and otherstandards. A systematic procedure for feedback of Achievementsagainst standards laid should be established.

Scrap may be treated in Cost Accounts in the following ways :

(i) Where the value of scrap is negotiable, it may be excluded fromcosts. In other words, the cost of scrap is borne by good units

and income from scrap is treated as other income.

(ii) If the scrap value is considerable, the net sale proceeds of scrap(Gross sales proceeds of scrapthe cost of selling scrap) isdeducted from the material cost or factory overhead. Under thismethod the material cost or factory overhead recovery rate arereduced on account of sale proceeds of scrap. However, nodistinction is made between various processes or jobs.

(iii) Where the various jobs or processes give rise in varyingamount of scrap, the scrap from each job or process is recordedseparately and the sale proceeds from the same credited to the

particular job or process. This method is useful where scrap is ofconsiderable value and does not arise uniformly. However, thiswould necessitate the scrap being identified with various jobs orprocesses. For this purpose detailed records for scrap will berequired.

Control of scrap really arises at the maximum effectiveutilization of the raw material. Scrap control does not, therefore,start in the production department; it starts from the stage ofproduct designing. Thus the most suitable type of materials, theappropriate size, the right type of equipment and personnel would

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help getting maximum quantity of finished product from a given rawmaterial.

The procedure for control of scrap should start with establishinga standard of scrap with each department, job or process, takinginto consideration the nature of material, the nature of themanufacturing operation, the use of proper equipment, the size ofthe material, the employment of proper personnel and definingareas of responsibility. It is also necessary to establish a scheme ofscrap reporting. The actual scrap should be compared with thepredetermined standard, and the reasons for the difference, if any,should be investigated, corrective action taken, whenever the actual

scrap is found to be more than what is normally allowed. Also, it is tobe ensured that proper supervision is exercised at the scrapgeneration stage.

Question 8

What is ABC analysis ? Discuss its role in a sound system ofmaterial control.

Answer

ABC analysis is a technique through which selective control canbe exercised over the various items of inventory. These days themanufacturing units have such a large number of items in theirstores that it is often not possible for the management to payminute attention to each and every item. A system is thereforedivised by which these items are classified according to theirimportance and then selective control exercised. ABC analysis orSelective Inventory Control is a technique whereby the measure ofcontrol over an item of inventory varies directly with its usage value.In other words, the high value items are controlled more closely thanthe items of low value.

To classify the various items according to their usage value, thefollowing procedure is adopted:

(a) The quantity or the number of parts expected to be used forproduction in the given period is estimated.

(b) The quantity as estimated above is multiplied by the unit valueof the item.

(c) All the items are then re-arranged according to their usage valuein a descending order.

(d) It would normally be found that a small number of items addupto a very high value. Thus 5 to 10 percent of total items may

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constitute 70 to 85 percent of material cost. Such items areclassified as A items. Another 10 to 20 percent of total itemsmay represent 10 to 20 percent of the total material cost. Theseitems may be categorised as B items. The rest, i.e. 70 to 85-percent of items, though numerous, will thus form only 5 to 10percent of total material cost. These may be called C items.

This classification thus highlights the more significant items.Management can then exercise a very close control over A items. Itmay apply occasional control over B items. As regards C items, itmay exercise control only in a general manner. For example, it mayorder the quantities of C items annually or once in six months or so.

It is obvious that since C items do not have a high value, the totalinvestment in such items will not be large.

Regarding A items, the management will have to define thestock levels, i.e., maximum, minimum, reordering and danger verycarefully. Also a close check on the consumption of these items willhave to be kept. The economic order quantity for each of the itemsin this category should be worked out. Similarly other technique ofinventory control should also be applied to A items. It would beappreciated that since A items constitute the bulk of the investmentin the total inventory, it would be worthwhile to bring them underclose control and to apply modern management inventory control

techniques.

ABC analysis helps the management in the following ways:

(1) The investment in inventories is optimised through a close anddirect control over A items. This would naturally release fundswhich can then be channelised into more profitable areas. Thiswould raise the overall return on investment earned by the unit.

(2) The ordering and carrying costs are reduced since themanagement would attempt to optimise such costs so far asthey relate to the bulk of the items.

(3) If the management seeks to exercise direct control over all the

items of inventory, the inventory control system would becomevery expensive. ABC analysis therefore cuts down the cost of thesystem and relates its cost to the attendant benefits.

(4) The main objectives of inventory control are fulfilled under thissystem at the minimum cost. With scientific control ofinventories, the stock turnover rate can be maintained atcomparatively high levels.

The concept of ABC analysis can be used in areas other thaninventory also. This technique basically emphasises that where the

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items to be controlled are numerous, one should categorise themaccording to their importance. Close control should then beexercised on the most significant category. On the less importantcategories, the degree of control maybe related to the benefit fromcontrol.

Thus finally it may be concluded that ABC analysis plays animportant role for a sound system of material control.

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Question 9

Distinguish between

(a) Perpetual Inventory System and continuous stock taking.

(b) Bill of materials and material requisition note

Answer

(a) Distinction between Perpetual Inventory System andContinuous Stock taking

Perpetual Inventory System: It is a system of stock control

followed by the stores department. Under this system, acontinuous record of receipt and issue of material is maintainedby the stores department. In other words, in this system, stockcontrol cards or bin cards and the stores ledger show clearly thereceipts, issues and balance of all items in stock at all times.

This system facilitates planning of production and ensures thatproduction is not interrupted for want of materials and stores.

Continuous Stock taking: It means physical verification of storesitems on a continuous basis to reveal the position of actualbalances. Such a verification is conducted round the year, thuscovering each item of store twice or thrice. Any discrepancies,

irregularities or shortages brought to the notice, as a result ofcontinuous stock verification are reported to the appropriateauthorities for initiating necessary rectification measures. Thissystem works as a moral check as stores staff and acts as adeterrent to dishonesty.

A perpetual inventory system is usually supported by aprogramme of continuous stock taking. That is continuous stocktaking is complementary to the perpetual inventory system.Sometimes the two terms are considered synonymous but it isnot so. The success of the perpetual inventory system dependsupon the maintenance and upto date writing up of (i) the stores

ledger and (ii) bincards/stock control cards, Continuous stocktaking, ensures the veracity of figures shown by the aboverecords

(b) Distinction between bill of materials and materialrequisition note.

Bill of materials: It is a list of material: required either for aparticular job or for a work order. It contains the description;code and quantity of materials and other stores items requiredfor a particular job or work order. It serves as an advance

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intimation to stores department about the requirement ofmaterials. It acts as an authorisation for the issue of all materialsand stores items mentioned in the bill of materials. Its usereduces paper work and ensures requisition of the exact quantityof materials to the user department.

Material requisition note: It is a formal request, for the supply ofspecified materials, stores etc., to the production department fora specific job or work order. It authorises the issuing departmentto draw from stores the requisitioned materials. Such a notecontains information about the description, code and quantity ofmaterials needed. It also has job/work order number for which

the material has been requisitioned. This note is signed by theForeman of the concerned department.

Question 10

Distinguish amongst:

Waste

Spoilage

Salvage

Rectification

Scrap.

How are they treated in Cost Accounts.

Answer

Waste : It represents the portion of basic raw materials lost inprocessing having no recoverable value. Waste may be visible-remnants of basic raw materialsor invisible, e.g., disappearance ofbasic raw materials through evaporation, smoke etc.

Normal waste is absorbed in the cost of net output, whereasabnormal waste is transferred to the Costing Profit and LossAccount.

For effective control of waste, normal allowances for yield andwaste should be made from past experience, technical factors andspecial features of the material process and product. Actual yieldand waste should be compared with anticipated figures andappropriate actions should be taken where necessary. Responsibilityshould be fixed on purchasing, storage, maintenance, productionand inspection staff to maintain standards. A systematic procedure

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for feedback of achievement against laid down standards should beestablished.

Spoilage : It is the term used for materials which are badlydamaged in manufacturing operations, and they cannot be rectifiedeconomically and hence taken out of process to be disposed of insome manner without further processing. Spoilage maybe eithernormal or abnormal.

Normal spoilage (i.e., which is inherent in the operation) costsare included in costs either by charging the loss due to spoilage tothe production order or charging it to production overhead so that itis spread over all products. Any value realised from spoilage iscredited to production order or production overhead account, as thecase may be.

The cost of abnormal spoilage (i.e., arising out of causes notinherent in manufacturing process) are charged to the Costing Profitand Loss Account. When spoiled work is the result of rigidspecification, the cost of spoiled work is absorbed by goodproduction while the cost of disposal is charged to productionoveread.

To control spoilage, allowance for normal spoilage should befixed and actual spoilage should be compared with standard set. A

systematic procedure of reporting would help control over spoilage.A spoilage report should highlight the normal and abnormalspoilage, the department responsible, the causes of spoilage andthe corrective action taken, if any.

Salvage: Salvaged material refers to the material retrieved fromthe spoiled work. Salvage is the process by which salvaged materialis retrieved. The salvaged units of material are usable in theproduction.

The value of salvaged material may be credited to the accountto which spoilage is charged.

Rectification: It means bringing back the defective units either tostandard units of production or as seconds, by reworking. The workof rectification in small concern's is usually entrusted to theproduction shop, whereas in big concerns, a separate departmentcarries out the task. Before the start of rectification work anestimate of the cost of rectification is prepared and compared withthe excess value to be obtained after rectification. The concern onlygoes ahead with the task of rectification if the aforesaid comparisonis found favourable.

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The task of rectification is usually carried out under a'Rectification Work Order', and all costs of re-work are collectedagainst this work order for material, labour and overhead.

If the defective production is inherent in the process ofmanufacture, and arises as a normal consequence of productiveactivities and if it can be identified with specific jobs, therectification cost is charged to the jobs as the cost of manufacturinggood units of the product. This will have the effect of adding to thecost of the jobs. If the expenditure on rectification is consideredabnormal, it is excluded from product costs and charged to CostingProfit and Loss Account.

Scrap: It has been defined as the incidental residue from certaintypes of manufacture, usually of small amount and low value,recoverable without further processing. Scrap may be treated tocost accounts in the following ways:

(i) Where the value of scrap is negligible, it may be excluded fromcosts. In other words, the cost of scrap is borne by good unitsand income from scrap is treated as other income.

(ii) The sales value of scrap, net of selling and distribution cost, isdeducted from over-head to reduce the overhead rate. Avariation of this method is to deduct the net realisable value

from material cost. This method is followed when scraps cannotbe segregated job or process-wise.

(iii) When scrap is identifiable with a particular job or process and itsvalue is significant, the scrap account should be charged withfull cost. The credit is given to the job or process concerned. Theprofit or loss in the scrap account, on realisation, will betransferred to the Costing Profit and Loss Account.

Control of scrap really means the maximum effective utilisationof raw material. Scrap control does not, therefore, start in theproduction department, it starts from the stage of productdesigning. Thus the most suitable type of materials, the right type of

equipment and personnel would help in getting maximum quantityof finished product from a given raw material.

A standard allowance for scrap should be fixed and actual scrapshould be collected, recorded and reported, indicating the costcentre responsible for it. A periodical scrap report would serve thepurpose where two or more departments or cost centres areresponsible for the scrap; the reports should be routed through thedepartments concerned.

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Question 11

Draw a proforma of "Bill of Materials". List down the Advantagesof using the same.

Answer

Proforma of

Bill of Materials

Job No. _________ No. ___________

Department authorised ___________ Date __________

S.No. CodeNo. orsize

Description

Qty. Date of Issueand Qty.issued

RateRs.

Amount Rs.

Date Qty.

Received by________Authorised by ___________________ Checked by ________ Store Keeper's Signature __________ Cost Clerk

Advantages of the using Bill of Materials

A bill of materials serves the purpose of an advance intimationto the concerned department of the orders to be executed. It isusually prepared in quadruples. A copy of it is usually sent to eachof the following department.

(i) Stores department

(ii) Cost Accounts department

(iii) Production Control departmentThe advantages of using "Bill of materials" by the above

departments may be summed up as follows:

Stores department

(1) A Bill of materials serves as an important basis of preparingmaterial purchase requisitions by stores department.

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(2) It acts as an authorisation for issuing total material requirement.

(3) The clerical activity is reduced as the stores clerk issues theentire/part of the material requirement to the users, if the detailsof material asked are present in the Bill of materials.

Cost Accounts department

(1) "Bill of materials" is used by Cost accounts department forpreparing an estimate / budget of material cost for the

job/process / operation, it is meant.

(2) It may be used as a device for controlling the excess cost ofmaterial used. This is done after determining material variances

and ascertaining the reasons for their occurrence.

Production Control Department

(1) "Bill of materials" may be used by this department for controllingusage of materials.

(2) Its usage saves time which otherwise would have been wastedfor preparing separate requisitions of material.

Question 12

Write notes on Bill of Material(May, 1998, 4 marks)

Answer

Bill of material

In most of the manufacturing units a list of materials required fora particular work or job order is prepared. Such a list is usuallyprepared either by the engineering or production planningdepartment. This list is known as a bill of material.

Bill of materials has code; description and quantity of materialsand other stores items required for carrying out a particular work or

job order. It also acts as an authorisation for the issue of materials

and stores items mentioned in it. Use of Bill of materials saves paperwork and also ensures requisition of the exact quantity of materials.It also saves the botheration of stores people of preparing andissuing a number of material requisition slips It also acts as anadvance intimation to stores and purchase department about therequirements of materials.

Generally four copies of it are prepared, one for each of thefollowing departments.

(a) Stores department

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Materials

(b) Production department

(c) Cost Accounts department

(d) Production planning department.

Question 13

How are normal and abnormal loss of material arising duringstorage treated in Cost Accounts?

(May, 2001, 5 marks)

Answer

Cost Accounts treatment of normal and abnormal loss ofmaterial arising during storage.

The difference between the book balance and actual physicalstock, which may either be gain or loss, should be transferred toInventory Adjustment Account pending scrutiny to ascertain thereason for the difference.

If on scrutiny, the difference arrived at is considered as normal,then such a difference should be transferred to overhead controlaccount and if abnormal, it should be debited to costing profit andloss account.

In the case of normal losses, an alternative method may beused. Under this method the price of the material issued toproduction may be inflated so as to cover the normal loss.

Question 14

Distinguish clearly Bincards and Sores Ledger (May, 1999, 4marks)

Answer

Both bin cards and stores ledger are perpetual inventoryrecords. None of them is a substitute for the other. These two

records may be distinguished from the following points of view:(i) Bin card is maintained by the store keeper, while the stores

ledger is maintained by the cost accounting department.

(ii) Bin card is the stores recording document whereas the storesledger is an accounting record.

(iii) Bin card contains information with regard to quantities i.e. theirreceipt, issue and balance while the stores ledger contains bothquantitative and value information in respect of their receipts,issue and balance.

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Cost Accounting

(iv) In the bin card entries are made at the time when transactiontakes place. But in the stores ledger entries are made only afterthe transaction has taken place.

(v) Inter departmental transfer of materials appear only in storesledger.

(vi) Bin cards record each transaction but stores ledger records thesame information in a summarized form.

Question 15

What is Just in Time (JIT) purchases? What are the advantages of

such purchases?(May,1999, 3 marks)

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Materials

Answer

Just in time (JIT) purchases means the purchase of goods ormaterials such that delivery immediately precedes their use.

Advantages of JIT purchases:

Main advantages of JIT purchases are as follows:

1. The suppliers of goods or materials cooperates with thecompany and supply requisite quantity of goods or materials forwhich order is placed before the start of production.

2. JIT purchases results in cost savings for example, the costs of

stock out, inventory carrying, materials handling and breakageare reduced.

3. Due to frequent purchases of raw materials, its issue price islikely to be very close to the replacement price. Consequentlythe method of pricing to be followed for valuing material issuesbecomes less important for companies using JIT purchasing.

4. JIT purchasing are now attempting to extend daily deliveries toas many areas as possible so that the goods spend less time inwarehouses or on store shelves before they are exhausted.

Question 16

Distinguish between perpetual inventory and continuous stocktrading.

(November, 1996, 4 marks)

Answer

Perpetual Inventory and Continuous Stock Taking:

Perpetual Inventory is a system in which a continuous record ofreceipt and issue of materials is maintained by the storesdepartment. In this system the stock control cards, bin cards andstores ledger show the receipts, issue and balance of each item atany point of times after each transaction. The stocks as per dualrecords namely bin card and stores ledger are reconciled on acontinuous basis. The system facilitates planning and control.

Continuous Stock taking is a system of physical verification ofstocks of each item on continuous basis. The actual quantity in thebincard is compared with bin balances. Such a verification isconducted round the year such that all items of stocks are verified 3to 4 times in a year. Any discrepancies are investigated and

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Cost Accounting

reported for corrective action. It also serves as a moral check onstores staff and acts as deterrent to dishonesty.

A Perpetual Inventory System is usually supported by ContinuousStock taking. It calls for upto date .writing up of stores/ledger andbin cards and stock control-cards. The balances as per bin card andstores ledger are compared when every receipt or issue is posted.

The physical balance on continuous stock taking is also comparedwith the bincard or ledger balances. Thus-monthly accounts can beprepared with confidence.

Question 17

Discuss the accounting treatment of defectives in cost accounts(May, 2000, 4 marks)

Answer

Accounting treatment of defectives in cost accounts:

Defectives refers to those units or portions of production, whichdo not meet the prescribed specifications. Such units can bereworked or re-conditioned by the use of additional material, labour

and /or processing and brought to the point of either standard orsub-standard units.

The possible way of treating defectives in cost accounts are asbelow:

1. When defectives are normal and it is not beneficial to identitythem job-wise, then the following methods may be used.

(a) Charged to good products:The cost of rectification of normaldefectives is charged to good units. This method is usedwhen defectives rectified are normal.

(b) Charged to general overheads. If the department responsible

for defectives cannot be identified, the rework costs arecharged to general overheads.

(c) Charged to departmental overheads: If the departmentresponsible for defectives can be correctly identified, therectification costs should be charged to that department.

2. When normal defectives are easily identifiable with specific jobthe rework costs are debited to the identified job.

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Materials

3. When defectives are abnormal and are due to causes within thecontrol of the organisation, the rework cost should be charged tothe Costing Profit and Loss Account.

Question 18

Discuss the concept of Economic Batch Quantity (EBQ) (May,2000, 2 marks)

Answer

Economic batch quantity: Production is usually done inbatches and each batch can have any number of units of acomponent in it. The optimum quantity for a batch is that quantityfor which the setting up and carrying costs are minimum. Such anoptimum quantity is known as "Economic batch quantity". Theformula used to determine the economic batch quantity (EBQ) is:

EBQ =C

DS2

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Cost Accounting

where, EBQ = Economic batch quantity

D = Demand of the components in a year

S = Setting up cost per batch

C = Carrying cost p.u. per annum

Question 19

Explain the concept of "ABC Analysis" as a technique ofinventory control

(May, 2000, 3 marks)

Answer

ABC Analysis: It is a system of selective inventory controlwhereby the measure of control over an item of inventory varieswith its usage value. It exercises discriminatory control overdifferent items of stores grouped on the basis of the investmentinvolved,. Usually the items of material are grouped into threecategories viz; A, B and C according to their use value during aperiod. In other words, the high use value items are controlled moreclosely than the items of low use value.

(i) 'A' Category of items consists of only a small percentage i.e.,

about 10 % of the total items of material handled by the storesbut require heavy investment i.e., about 70% of inventory value,because of their high prices and heavy requirement.

(ii) 'B' Category of items comprises of about 20% of the total itemsof material handled by stores. The percentage of investmentrequired is about 20% of the total investment in inventories.

(iii) 'C category of items does not require much investment. It maybe about 10% of total inventory value but they are nearly 70% ofthe total items handled by stores.

'A' category of items can be controlled effectively by using a

regular system, which ensures neither over- stocking nor shortageof materials for production. Such a system plans its total materialrequirements by making budgets. The stocks of materials arecontrolled by fixing certain levels like maximum level, minimumlevel and re-order level. A reduction in inventory management costsis achieved by determining economic order quantities after takinginto account ordering cost and carrying cost. To avoid shortages andto minimize heavy investment of funds in inventories, thetechniques of value analysis, variety reduction, standardization etc.are used along with aforesaid techniques.

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Materials

In the case of 'B' category of items, as the sum involved ismoderate, therefore, the same degree of control as applied in 'A'category of items is not warranted. The order for the items,belonging to this category may be placed after reviewing theirsituation periodically. This category of items can be controlled byroutine control measures.

For 'C' category of items, there is no need of exercising constantcontrol. Orders for items in this group may be placed either after sixmonths or once in a year, after ascertaining consumptionrequirements.

Question 20

Distinguish between Re-order level and Re-order quantity

Answer

Re-order level & Re-order quantity: Re-order level is defined asthat level of an inventory item where a fresh order for itsreplenishment is placed. Mathematically it can be determined byusing the following formulas:

Re-order level (ROL) = [Maximum consumption x Maximum re-order period]

Alternatively: = Minimum level +

nconsumptio

orateAverage

perioorderre

Average

Re-order quantity (ROQ) is defined as that quantity of aninventory item for which order is placed again and again. Economicorder quantity is a re-order quantity but not vice-a-versa. It can bedetermined by using the following mathematical expression:

EOQ = ROQ =

annumperunitpertcoscarryingAnnualordepertcosOrderingunitsiniteminventoryoftrequiremenAnnual2

Question 21

Describe perpetual inventory records and continuous stockverification. (May, 2001, 3 marks)

Answer

Perpetual inventory records and continuous stockverification:

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Cost Accounting

Perpetual inventory records represents a system of recordsmaintained by the stores department. It in fact comprises of (i) Bincards, and (ii) Stores Ledger.

Bin cards maintains a quantitative record of receipts, issues andclosing balances of each item of stores. Separate bin cards aremaintained for each item. Each card is filled up with the physicalmovement of goods i.e. on its receipt and issue.

Like bin cards the stores ledger is maintained to record allreceipts and issues in respect of materials. Entries in it are madewith the help of goods received notes and material issuerequisitions.

A perpetual inventory record is usually checked by a programmeof continuous stock verification. Continuous stock verification meansthe physical checking of those inventory records (which aremaintained under perpetual inventory) with actual stock.

Perpetual inventory records helps in proper material control asdiscrepancies in physical stock and book figures are regularlyreconciled through continuous stock verification.

Question 22

"To be able to calculate a basic EOQ certain assumptions arenecessary. "List down these assumptions . (November, 1995, 2marks)

Answer

The computation of economic order quantity is subject tothe following assumptions:

(i) Ordering cost (per order) and carrying cost (per unit/annum) areknown and constant.

(ii) Anticipated usage (in units) of material for a period is uniformand known.

(iii) Cost per unit of the material (to be purchased) is known and it isconstant.

Question 23

Draw specimen draft of a 'Purchase Order'. (May, 1997, 4 marks)

Answer

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Materials

(a) Specimen draft of a 'Purchase Order'ABC Limited

___________

Purchase Order

No. ____________

Dated:__________

To

__________________

__________________

__________________

Dear Sirs,

With reference to your quotation No. ____ dated _____, has beenaccepted by our office. Please supply the following item of stores onthe terms and conditions listed on the reverse of this order; latest by

_______

S.No. Description Quantity RateRs.

AmountRs.

Terms of delivery: _________

Terms of Payment : _________

Packing and dispatch instructions: __________________

Bill to be sent to: Yours faithfully,

Purchase Officer

Question 24

How is slow moving and non-moving item of stores detected and

what steps are necessary to reduce such stocks?(November, 2001, 4 marks)

Answer

Detection of slow moving and non-moving item of stores:

The existence of slow moving and non-moving item of stores canbe detected in the following ways.

(i) By preparing and scanning periodic reports showing the status ofdifferent items or stores.

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Cost Accounting

(ii) By calculating the stock holding of various items in terms ofnumber of days/ months of consumption.

(iii) By computing ratios periodically, relating to the issues as apercentage of average stock held.

(iv) By implementing the use of a well designed informationsystem.

Necessary steps to reduce stock of slow moving and non-moving item of stores:

(i) Proper procedure and guidelines should be laid down for thedisposal of non-moving items, before they further deteriorates in

value.

(ii) Diversify production to use up such materials.

(iii) Use these materials as substitute, in place of other materials.

Question 25

Distinguish between Bin Card and Stores Ledger. (May, 2002, 2marks)

Answer

Bin Card Stores Ledger Bincards are maintained in thestores and are serving thepurpose of stock register.

Entries in it are posted by theissue clerk. He records thequantity about receipts, issuesand closing balance along withcode number of material,maximum, minimum and reorderlevels.

Here transactions are postedindividually.

Posting is done at the time ofissue of material.

Stores ledger is maintained inthe cost accounts department.

Here entries are posted by thestores ledger clerk. He recordsthe quantities and value aboutreceipts, issues and closingbalance along with code numberof material, maximum, minimumand reorder levels.

Here transactions can be postedperiodically.

Posting . is done after the issueof materials.

Question 26

Explain the advantages that would accrue in

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Materials

Using the LIFO method of pricing for the valuation of rawmaterial stock

Answer

(a) LIFO- Last-in-first-out: A method of pricing for the valuation ofraw material stock. It is based on the assumption that the itemsof the last batch(lot) purchased are the first to be issued.

Therefore, under this method, the price of the last batch(lot) ofraw material is used for pricing raw material issues until it isexhausted. If, however, the quantity of raw material issued ismore than the quantity of the latest lot, the price of the last but

one lot and so on will be taken for pricing the raw materialissues.

The advantages that would accrue from the use of LIFO methodof pricing the valuation of raw materials, are as follows:-

(i) The cost of materials used is nearer to the current market price.Thus the cost of goods produced depends upon the trend of themarket price of materials. This enables the matching of cost ofproduction with current sales revenues.

(ii) Use of LIFO during the period of rising prices does not depictunnecessarily high profit in the income statement; compared to

the first-in-first-out or average methods. The profit shown by theuse of LIFO is relatively lower, because the cost of productiontakes into account the rising trend of material prices.

(iii) When price of materials fall, the use of LIFO method accountsfor rising the profits due to lower material cost. Inspite of thisfinished product appears to be more competitive and at marketprices.

(iv) Over a period, the use of LIFO will iron out the fluctuations inprofit.

(v) During inflationary period, the use of LIFO will show the correctprofit and thus avoid paying unduly high taxes to some extent.

Question 27

What is a purchase requisition? Give a specimen form of apurchase requisition.

(November, 1998, 4 marks)

Answer

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Cost Accounting

A Purchase requisition is a form used for making a formalrequest to the purchasing department to purchase materials.Purchase requisitions are usually initiated by

(i) A store department for regular and standard items held in thestock.

(ii) The production control department for special materialrequired for specific jobs.

(iii) The maintenance department for maintenance equipmentand items of capital expenditure.

(iv) The heads of departments for office equipments.

The aforesaid arrangement is only a matter of convenience. Insome concerns distinction is made between regular indents andspecial indents, depending upon whether the items are needed forreplacing stocks or for special orders. But both types of indents areinitiated by the stores department. Irrespective of the differencesregarding the procedure for initiating purchase requisition, thepurchase manager should have with him a list of the personsauthorised to requisition materials.

Each purchase requisition should clearly state the quantity,quality and other specifications in the appropriate column of the

given specimen form along with the purpose for which materials arerequired. It should also indicate the date by which such materialsare needed.

Depending upon the procedure to be followed appropriatenumber of copies of the purchase requisitions may be prepared andused accordingly. A specimen form of purchase requisition is givenbelow:-

A specimen form of purchase requisition

Date ____________ For Stock Date of requirement________

Req. No._________ Dept. or work order No.______ Sl. No. Code No. Descriptio

nQuantity Grade Remarks

Requisitioned by _________ Checked by __________ Approved by____________

For Purchase Department use

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Materials

Purchase Order No. _____________ Date of Purchase___________________

Name of supplier ________________ Expected date of delivery____________

Question 28

What do you understand by ABC analysis of inventory control ? Afactory uses 4,000 varieties of inventory. In terms of inventoryholding and inventory usage, the following information is compiled:

No. of

varieties ofinventory

% % value of inventory

holding (average)

% of inventory

usage (in end-product)

3,875 96.875 20 5

110 2.750 30 10

15 0.375 50 85

4,000 100.000 100 100

Classify the items of inventory as per ABC analysis with reasons.(November, 1998, 6 marks)

Answer

ABC Analysis: It is a system of selective inventory controlwhereby the measure of control over an item of inventory varieswith its usage value. It exercises discriminatory control overdifferent items of stores grouped on the basis of the investmentinvolved. Usually the items of material are grouped into threecategories viz; A, B and C according to their use value during aperiod. In other words, the high use value items are controlled moreclosely than the items of low use value.

(i) 'A' Category of items consists of only a small percentage i.e.,

about 10% of the total items of material handled by the storesbut require heavy investment i.e., about 70% of inventory value,because of their high prices and heavy requirement.

(ii) 'B' Category of items comprises of about 20% of the totalitems of material handled. by stores. The percentage ofinvestment required is about 20% of the total investment ininventories.

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Cost Accounting

(iii) 'C' category of items do not require much investment. It maybe about 10% of total inventory value but they are nearly 70%of the total items handled by stores.

'A' category of items can be controlled effectively by using aregular system which ensures neither over-stocking nor shortageof materials for production: Such a system plans its totalmaterial requirements by making budgets. The stocks ofmaterials are controlled by fixing certain levels like maximumlevel, minimum level and re-order level. A reduction in inventorymanagement costs is achieved by determining economic orderquantities after taking into account ordering cost and carrying

cost. To avoid shortages and to minimize heavy investment offunds in inventories, the techniques of value analysis, varietyreduction, standardisation etc. are used along with aforesaidtechniques.

In the case of 'B' category of items, as the sum involved ismoderate, therefore the same degree of control as applied in 'A'category of items is not warranted. The orders for the items,belonging to this category may be placed after reviewing theirsituation periodically. This category of items can be controlled byroutine control measures.

For 'C' category of items, there is no need of exercising constantcontrol. Orders for items in this group, may be placed eitherafter six months 0r once in a year, after ascertainingconsumption requirements.

Classification of the items of inventory as per ABC analysis

1. 15 number of varieties of inventory items, should be classified as'A' category items because of the following reasons:(i) Constitute 0.375% of total number of varieties of inventory

items handled by stores of factory, which is minimum as pergiven classification in the table.

(ii) 50% of total use value of inventory holding (average) which

is maximum according to the given table.(iii) Highest consumption of about 85% of inventory usage (in

end-product).2. 110 number of varieties of inventory items, should be classified

as 'B' category items because of the following reasons:(i) Constitute 2.750% of total number of varieties of inventory

items handled by stores of factory.(ii) Requires moderate investment of about 30% of total use

value of inventory holding (average).

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Materials

(iii) Moderate consumption of about 10% of inventory usage(in end- product).

3. 3,875 number of varieties of inventory items, should beclassified as 'C' category items because of the following reasons:(i) Constitute 96.875% of total varieties of inventory items

handled by stores of factory.(ii) Requires investment of 20% of total use value of inventory

holding (average).(iii) Minimum consumption i.e. about 5% of inventory usage

(in end-product).

Question 29

The following information is extracted from the Stores Ledger:Material X

Opening Stock NilPurchases :

Jan.1 100 @ Re. 1 perunit

Jan. 20 100 @ Rs. 2 perunit

Issues:Jan. 22 60 for Job W 16Jan 23 60 for Job W 17

Complete the receipts and issues valuation by adopting theFirst-in First-Out, Last-in First Out and the Weighted AverageMethod. Tabulate the values allocated to Job W 16, Job W 17 and theclosing stock under the methods aforesaid and discuss from thedifferent points of view which method you would prefer.

Answer

See next pages for Statements.

From the point of view of cost of material charged to each job, itis minimum under FIFO and maximum under LIFO. During the periodof rising prices, the use of FIFO gives rise to high profits and that ofLIFO low profits. In the case of weighted average there is nosignificant adverse or favourable effect on the cost of material aswell as on profits.

From the point of view of valuation of closing stock it is apparentfrom the above statement that it is maximum under FIFO, moderateunder weighted average and minimum under LIFO.

It is clear from the above that the use of weighted averageevens out the fluctuations in the prices. Under this method, the cost

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Cost Accounting

of materials issued to the jobs and the cost of material in handreflects greater uniformity than under FIFO and LIFO. Thus fromdifferent points of view, weighted average method is preferred overLIFO and FIFO.

Answer

Statement of Receipts and Issues byadopting First-in-First-Out Method

Date Particulars

Receipts Issues BalanceUnit

s

No.

Rate

Rs.

Val

ue

Rs.

Units

No.

Rate

Rs.

Value

Rs.

Units

No.

Rate

Rs.

Value

Rs.

Jan 1 Purchas

e

100 1 100 100 1 100

Jan

20

Purchas

e

100 2 200 100 1 100

100 2 200

Jan.

22

Issue to

Job W

16

60 1 60 40

100

1

2

40

200

Jan.

23

Issue to 40 1 40

Job W

17

20 2 40 80 2 160

Statement of Receipts and Issues by adopting Last-In-First-Out

method

Date Particul

ars

Receipts Issues Balance

Unit

s

No.

Rate

Rs.

Value

Rs.

Units

No.

Rat

e

Rs.

Value

Rs.

Units

No.

Rate

Rs.

Value

Rs.

Jan 1 Purchas

e

100 1 100 100 1 100

Jan

20

Purchas

e

100 2 200 100 1 100

100 2 200

Jan.

22

Issue to 60 2 120 100 1 100

Job W

16

40 2 80

Jan. Issue to 40 2 80 80 1 80

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Materials

23

Job W

17

20 1 20

Statement of Receipt and Issues by adopting Weighted Average method

Date Particulars Receipts Issues Balance

Unit

s

No.

Rate

Rs.

Valu

e

Rs.

Unit

s

No.

Rate

Rs.

Valu

e

Rs.

Units

No.

Rate

Rs.

Value

Rs.

Jan 1 Purchase 100 1 100 100 1 100

Jan

20

Purchase 100 2 200 200 1.50 300

Jan.

22

Issue to Job

W 16

60 1.50 90 140 1.50 210

Jan.

23

Issue to 60 1.50 90 80 1.50 120

Job W 17

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Cost Accounting

Statement of Material values allocated to Job W 16, Job W 17

and Closing Stock, under aforesaid methods

FIFO LIFO WeightedAverage

Rs. Rs. Rs.

Material for JobW 16

60 120 90

Material for JobW 17

80 100 90

Closing Stock 160 80 120

300 300 300

Question 30

AT Ltd. furnishes the following stores transactions forSeptember, 1982

1-9-82 Opening balance 25 Units value Rs.162.50

4-9-82 Issues Req. No. 85 8 Units

6-9-82 Receipts from B & Co. GRN NO. 26 50 Units @ Rs. 5.75per unit

7-9-82 Issues Req. No. 97 12 Units10-9-82

Returns to B & Co. 10 Units

12-9-82

Issues Req. No. 108 15 Units

13-9-82

Issues Req. No.110 20 Units

15-9-82

Receipts from M & Co. GRN NO. 33 25 Units @ Rs. 6.10per unit

17-9-82

Issues Reg. No. 121 10 Units

19-9-82

Received replacement from B & Co.GRN No. 38

10 Units

20-9-82

Returned from department materialofM & Co. MRR No.4

5 Units

22-9-82

Transfer from Job 182 to Job 187 inthe dept. MTR 6

5 Units

26-9-92

Issues Req. No. 146 10 units

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Materials

29-9-82

Transfer from Dept. "A" to Dept. "B"MTR 10

5 Units

30-9-82

Shortage in stock taking 2 Units

Write up the priced stores ledger on FIFO method and discusshow would you treat the shortage in stock taking.

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Cost Accounting

Answer

Stores Ledger of AT Ltd. for the month of

September, 1982 (FIFO method)

Date Receipt Issue Balance

GR

N

No.

MR

R

No.

Qt

y.

Un

its

Rate

Rs.

P.

Amou

nt

Rs. P.

Requisiti

on No.

Qty.

Units

Rate

Rs. P.

Amou

nt

Rs. P.

Qty.

Units

Rate

Rs. P.

Amou

nt

Rs. P.

1 2 3 4 5 6 7 8 9 10 11 12

1.9.82 25 6.50 162.5

0

4.9..8

2

85 8 6.50 52 17 6.50 110.5

0

6.9.82 26 50 5.75 287.5

0

17

50

6.50

5.75 398.0

0

7.9.82 97 12 6.50 78 5

50

6.50

5.75 320.0

0

10.9.8

2

Nil 10 5.75 57.50 5

40

6.50

5.75 262.0

0

12.9.8

2

108 5

10

6.50

5.75 90 30 5.75 172.5

0

1 2 3 4 5 6 7 8 9 10 11 12

13.9.8

2

110 20 5.75 115 10 5.75 57.50

15.9.8

2

33 25 6.10 152.5

0

10

25

5.75

6.10 210.0

0

17.9.8

2

121 10 5.75 57.50 25 6.10 152.5

0

19.9.8

2

38 10 5.75 57.50 25

10

6.10

5.75 210.0

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Materials

0

20.9.8

2

4 5 5.75 28.75 5

25

10

5.75

6.10

5.75 238.7

5

26.9.8

2

146 5

5

5.75

6.10 59.29

20

10

6.10

5.75 179.5

0

30.9.8

2

Shorta

ge

2 6.10 12.20 18

10

6.10

5.75 167.3

0

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Cost Accounting

Working Notes

1. The material received as replacement from vendor is treated asfresh supply.

2. In the absence of information the price of the material receivedfrom within on 20.9.82 has been taken as the price of the earlierissue made on 17.9.82. In FIFO method physical flow of thematerial is irrelevant for pricing the issues.

3. The issue of material on 26.9.82 is made out of the materialreceived from within.

4. The entries for transfer of material from one job and department

to other on 22.9.82 and 29.9.82 are book entries for adjustingthe cost of respective jobs and as such they have not beenshown in the stores ledger account.

5. The material found short as a result of stock taking has beenwritten off.

Treatment of shortages in stock taking:

At the time of stock taking generally discrepancies are foundbetween physical stock shown in the bin card and stores ledger.

These discrepancies are in the form of shortages or losses. The ;causes for these discrepancies may be classified as unavoidable or

avoidable.Losses arising from unavoidable causes should be taken care of

by setting up a standard percentage of loss based on the study ofthe past data. The issue prices may be inflated to cover the standardloss percentage. Alternatively, issues may be made at the purchaseprice but the cost of the loss or shortage may be treated asoverheads.

Actual losses should be compared with the standard and excesslosses should be analysed to see whether they are due to normal orabnormal reasons. If they are attributable to normal causes, anadditional charge to overheads should be made on the basis of thevalue of materials consumed. If they arise from abnormal causes,they should be charged to the Costing Profit and Loss Account.

Avoidable losses are generally treated as abnormal losses. Theselosses should be debited to the Costing Profit and Loss Account.

Losses or surpluses arising from errors in documentation,posting etc. should be corrected through adjustment entries.

Question 31

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Materials

A manufacturer of Surat purchased three Chemicals A, B and Cfrom Bombay. The invoice gave the following information:

Rs.

Chemical A :3,000 kg @ Rs. 4.20 per kg.

12,600

Chemical B:5,000 kg @ Rs. 3.80 per kg.

19,000

Chemical C:2,000 kg. @ Rs. 4.75 per kg.

9,500

Sales Tax 2,055

Railway Freight 1,000Total Cost 44,155

A shortage of 200 kg in Chemical A, of 280 kg. in Chemical B andof 100 kg. in Chemical C was noticed due to breakages. At Surat, themanufacturer paid Octroi duty @ Re 0.10 per kg. He also paidCartage Rs. 22 for Chemical A, Rs. 63.12 for Chemical B and Rs.31.80 for Chemical C. Calculate the stock rate that you wouldsuggest for pricing issue of chemicals assuming a provision of 5%towards further deterioration.

Answer

Statement showing the Issue Rate of Chemicals

Chemicals

A B C

Rs. Rs. Rs.

Purchase Price 12,600 19,000 9,500

Add: Sales Tax @ 5% of purchase price

630 950 475

(Refer to Working Note 2)

Add: Railway Freight in the ratioof 3:5:2

300 500 200


Add: Octroi @ Re. 1.10 p.per kg.

On the quantity of materialreceived

280 472 190


Add: Cartage 22 6312 31.80

Total Price 13,832 20,985.12 10,396.80

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Cost Accounting

Rate of issue per Kg =

kg.1,805

80Rs.10,396

4,484Kg.

12Rs.20,985.

kg.2,660

Rs.13,832

issueforavailableQty.

priceTotal=

(Refer to Working Note 1) = Rs.5.20= Rs. 4.68 = Rs. 5.76

Working Notes:

1. Statement showing the quantity of chemicals available for issue

Chemicals

A B C

Kg. Kg. Kg.

Quantity purchased 3,000 5,000 2,000Less: Shortage (Assumed to benormal

200 280 100

Quantity received at the store 2,800 4,720 1,900

Less: Provision for furtherdeterioration 5%

140 236 95

Quantity available for issue 2,660 4,484 1,805

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Materials

2. Rate of sales Tax=ChemicofpricePurchaseTotal

TaxSales100 =

10,41.Rs

055,2.Rs

100 = 5%

3. Railway Freight: It has been charged on the basis of quantitypurchased i.e. A:3000 kg; B: 5000 kg; C: 2000 kg in the ratio of3:5:2.

Question 32

Shriram Enterprises manufactures a special product "ZED". Thefollowing particulars were collected for the year 1986:

(a) Monthly demand of ZED-1,000 units.

(b) Cost of placing an order Rs. 100.

(c) Annual carrying cost per unit Rs. 15.

(d) Normal usage 50 units per week

(e) Minimum usage 25 units per week.

(f) Maximum range 75 units per week

(g) Re-order period 4 to 6 weeks.

Compute from the above

(1) Re-order Quantity

(2) Re-order level

(3) Minimum Level

(4) Maximum Level

(5).Average Stock Level

Answer

1. Re-order Quantity of units used =C

2AS

(Refer to note)

Where A = Annual demand of input units

S = Cost of placing an order

C = Annual carrying cost per unit

=15.Rs

10.Rs26002

= 186 units (approximately)

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Cost Accounting

2. Re-order Level = Maximum re-orderperiod maximum usage

= 6 weeks 75 units = 450 units

3. Minimum Level = Re-order Level Normal usage average re-order period)

= 450 units 50 units 5 weeks.

= 450 units 250 units = 200 units

4. Maximum Level = Re-order level + Re order quantity (Minimum

usage Minimum re-order period)

= 450 unit + 186 units 25 units 4weeks

= 536 units

5. Average Stock Level =2

1(Minimum Stock

Level + Maximum Stock Level)

=2

1(200 units + 536 units)

= 368 unitsNote : A = Annual demand of

input units for 12,000 units of "ZED"

= 52 weeks Normal usage of input perweek

= 52 weeks 50 units of input per week

= 2,600 units

Question 33

(a) What is Economic Order Quantity?

(b) The Purchase Department of your organisation has received anoffer of quantity discounts on its order of materials as under:

Price per tonne Tonnes

Rs.

1,400 Less than 500

1,380 500 and less than 1,000

1,360 1,000 and less than 2,000

1,340 2,000 and less than 3,000

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Materials

1,320 3,000 and above

The annual requirement of the material is 5,000 tonnes. Thedelivery cost per order is Rs. 1,200 and the annual stock holdingcost is estimated at 20 per cent of the average inventory.

The Purchase Department wants you to consider the followingpurchase options and advise which among them will be the mosteconomical ordering quantity, presenting the relevant information ina tabular form.

The purchase quantity options to be considered are 400 tonnes,500 tonnes, 1,000 tonnes, 2,000 tonnes and 3,000 tonnes

Answer

(a) Economic Order Quantity: Economic order quantity representsthe size of the order for which both ordering and carrying coststogether are minimum. If purchases are made in largequantities, inventory carrying cost will be high. If the order sizeis small, ordering cost will be high. Hence, it is necessary todetermine the order quantity for which ordering and carryingcosts are minimum. The formula used for determining economicorder quantity is as follows:

EOQ =CAO2

Where:

A is the annual consumption of material in units

O is the cost of placing an order (ordering cost per order)

C is cost of interest and storing one unit of material for oneyear (carrying cost per unit per annum)

(b)

Total

AnnualRequi

re-ment(

s)(tonnes)

Order

size(Q)(tonnes)

Pric

epertonne

No.

oforders S/Q

Cost of

inventory Spricepertonne

Ordering

Cost S/QRs.1,200

Carryin

g Costpertonne

p.a21

Q20% of

pricepertonne

Total

cost

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Cost Accounting

Rs. Rs. Rs. Rs. Rs. Rs.(1) (2) (3) (4)

=(1)/(2)

(5)=(1)(

3)

(6)=(4)Rs.1

,200

(7) (8)=(5)+(6)

+(7)

5000 400 1400

12.5 70,00,000

15,000 56,000 70,71,000

500 1380

10 69,00,000

12,000 69,000 69,81,000

1,000 1360

5 68,00,000

6,000 1,36,000

69,42,000

2,000 1340 2.5 67,00000 3,000 2,68,000 69,71,000

3,000 1320

1.67 66,00,000

2,000 3,96,000

69,98,000

Advice to Purchase Department: From the above table, it is clearthat the most economical order size among the given options is1,000 tonnes, as at this order size, the total cost is minimum.

Question 34

Component 'Pee' is made entirely in cost centre 100. Materialcost is 6 paise per component and each component takes 10minutes to produce. The machine operator is paid 72 paise per hour,and the machine hour rate is Rs. 1.50. The setting up of the machineto produce the component 'Pee' takes 2 hours 20 minutes.

On the basis of this information, prepare a cost sheet showingthe production and setting up cost, both in total and per component,assuming that a batch of:

(a) 10 components,

(b) 100 components, and

(c) 1,000 components is produced

Answer

Cost Sheet of Component 'PEE'

Batch Size 10

Total

Rs.

Per

componen

t Rs.

100

Total

Rs.

Per

Componen

t Rs.

1000

Total

Rs.

Per

Component

Rs.

Setting up

Cost: (A)

Machine 1.6 0.168 1.68 0.0168 1.68 0.00168

2.50

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Materials

Operators Wages 8

(2 hours 20

minutes @ 72

p.p.h.)

Overheads 3.5

0

0.350 3.50 0.035 3.50 0.0035

(2 hours 20

minutes @ Rs.

1.50 p.h.)

Production Cost

: (B)

Material Cost @ 6p. per component

0.60

0.06 6.00 0.06 60.00 0.06

Machine

Operators Wages

1.2

0

0.12 12.0

0

0.12 120.0

0

0.12

[Refer to Working

Note (i)]

Overheads 2.5

0

0.25 25.0

0

0.25 250.0

0

0.12

[Refer to Working

Note (ii)]

Total Cost (A +

B):

9.4

8

0.948 48.1

8

0.4818 435.1

8

0.43518

Working Notes

Components 10 100 1000

(i) Operators

Wages

Time taken in

minutes by

machine

Operators and

machine @ 10

minutes

per component 100 1000 1000

0Operators Wages

@ 72 p. per hour

(Rs.)

1.20 12.00 120.00

P72.060

100

P72.060

1000

P72.060

10000

(ii) Overhead

expenses

Total

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Cost Accounting

overhead

expenses in (Rs.)

@ Rs. 1.50

per machine hour

2.50 25.00 250.00

50.1.Rs60

100

50.1.Rs60

1000

50.1.Rs60

10000

Question 35

X Ltd. is committed to supply 24,000 bearings per annum to YLtd. on a steady basis. It is estimated that it costs 10 paise asinventory holding cost per bearing per month and that the set-up

cost per run of bearing manufacture is Rs. 324.

(a) What would be the optimum run size for bearing manufacture?

(b) Assuming that the company has a policy of manufacturing 6,000bearing per run, how much extra costs the company would beincurring as compared to the optimum run suggested in (a)above?

(c) What is the minimum inventory holding cost?

Answer

(a) Optimum production run (O) = I

UP2where

U = No. of units to be produced within on year.

P = Set-up cost per production run.

I = Carrying cost per unit per annum.

=1210.0

32.Rs000,242

= 3,600 bearings.

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Materials

(b) Total Cost (of maintaining the inventories) whenproduction run sizes (Q) are 3,600 and 6,000 bearingrespectively.

Total Cost = Total set-up cost + Total carrying cost.

(Total set up cost) Q=3,600 = (No. of production runs ordered) Set up cost per production run)

=600,3

00,24 Rs. 324 = Rs. 2,160 (1)

(Total set up cost) Q=6,000 =000,6

00,24 Rs. 324 = Rs. 1,296

(2)

(Total carrying cost) Q=3,600 =

21 Q I

=21 3,600 0.10P Rs. 12 = Rs.

2,160 (3)

(Total carrying cost) Q=6,000 =

21 6,000 0.10P Rs. 12 = Rs.

3,600 (4)(Total Cost) Q=3,600 = (1) + (3) =

Rs. 2,160 + Rs. 2,160 = Rs. 4,320(5)

(Total Cost) Q=6,000 = (2)+(4) =Rs. 1,296 + Rs. 3,600 = Rs. 4,896

(6)

Extra Cost incurred = (6) (5) =Rs. 4,896 Rs. 4,320 = Rs. 576

(c) Minimum inventory holding cost =

21 Q I

(When Q = 3,600 bearings)

=21 3,600 0.10 P Rs. 12

= Rs. 2,160

Question 36

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Cost Accounting

The following transactions in respect of material Y occurredduring the six months ended 30th June, 1988

Month Purchase(Units)

Price per UnitRs.

Issuedunits

January 200 25 Nil

February 300 24 250

March 425 26 300

April 475 23 550

May 500 25 800

June 600 20 400

(a) The chief accountant argues that the values of closing stockremains the same no matter which method of pricing of materialissues is used. Do you agree? Why or why not? Detailed storesledgers are not required.

(b) When and why would you recommend the LIFO method ofpricing material issues?

Answer

(a)The Closing Stock at the end of six months period i.e. on 30 June,1988 will be 200 units, whereas upto the end of May 1988, total

purchases coincide with the total issues i.e. 2,300 units. Itmeans at the end of May 1988, there was no closing stock. In themonth of June 1988, 600 units were purchased out of which 400units were issued. Since there was only one purchase and oneissue in the month of June 1988 and there was no opening stockon 1st June 1988, the Closing Stock of 200 units is to be valued atRs. 20/- per unit.

In view of this, the argument of the Chief Accountant appears tobe correct. Where there is only one purchase and one issue in amonth with no opening stock, the method of pricing of materialissues becomes irrelevant. Therefore, in the given case one

should agree with the argument of the Chief Accountant that thevalue of Closing Stock remains the same no matter whichmethod of pricing the issue is used.

It may, however, be noted that the argument of ChiefAccountant would not stand if one finds the value of the ClosingStock at the end of each month.

(b) LIFO method has an edge over FIFO or any other method ofpricing material issues due to the following advantages:

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Materials

(i) The cost of the materials issued will be either nearer or willreflect the current market price. Thus, the cost of goodsproduced will be related to the trend of the market price ofmaterials. Such a trend in price of materials enables thematching of cost of production with current sales revenues.

(ii) The use of the method during the period of rising prices doesnot reflect undue high profit in the income statement, as itwas under the first-in-first out or average method. In fact,the profit shown here is relatively lower because the cost ofproduction takes into account the rising trend of materialprices.

(iii) In the case of falling prices, profit tends to rise due to lowermaterial cost, yet the finished products appear to be morecompetitive and are at market price.

(iv)During the period of inflation, LIFO will tend to show thecorrect profit and thus, avoid paying undue taxes to someextent.

Question 37

The following information is provided by SUNRISE INDUSTRIESfor the fortnight of April, 1988:

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Cost Accounting

Material Exe :

Stock on 1.4.1988 100 units at Rs. 5 per unit.

Purchases

5-4-88 300 units at Rs. 6

8-4-88 500 units at Rs. 7

12-4-88 600 units at Rs. 8

Issues

6-4-88 250 units

10-4-88 400 units14-4-88 500 units

Required

(A) Calculate using FIFO and LIFO methods of pricing issues:

(a) the value of materials consumed during the period

(b) the value of stock of materials on 15-4-88.

(B) Explain why the figures in (a) and (b) in part A of thisquestion are different under the two methods of pricing ofmaterial issues used. You NEED NOT draw up the Stores

Ledgers.

Answer : (A)

(a) Value of Material Exe consumed during the period 1-4-88to 15-4-88 by using FIFO method.

Date Description Qty.Units

RateRs.

AmountRs.

1.4.88 Opening balance 100 5 500

5.4.88 Purchased 300 6 1,800

6.4.88 Issued 100

150

5

6

1,400

8.4.88 Purchased 500 7 3,500

10.4.88 Issued 150

250

6

7

2,650

12.4.88 Purchased 600 8 4,800

14.4.88 Issued 250

250

7

8

3,750

15.4.88 Balance 350 8 2,800

2.56

Documents

Costing Materials