Unit-2. Materials Account

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D.

(COMMERCE),
MBA (FINANCE), M.COM.)

CHAPTER – 2 MATERIALS ACCOUNTS – 1


MEANING OF MATERIALS:
Material is a substance, an integral part, from which the product is made and constitutes a
significant component of total cost. Depending upon the type of product manufactured, the
material cost may go up to 70-80% of the total cost.
CLASSIFICATION OF MATERIALS:
1.Raw Materials : The materials which are generally purchased from outside and consumed in
the process of manufacture are known as Raw Material.
2.Component Parts : When a finished product is made up of two or more parts assembled, the
parts may be purchased from outside sources or may be manufactured in the factory. The parts on
which, no any additional process is required and of which final article is made, are known as
component parts.
3. Semi-finished goods :Goods which are not in saleable state, on which some processes have
been performed, and which require further processing before being transferred into finished goods
go down are known as semi-finished goods.
4. Finished stock : The goods which are in saleable state, are known as Finished goods.
5. Consumable stores : Materials like oil, grease, cotton waste etc. which are required for
operating and maintaining the machinery and equipment's are termed as consumable stores.
6. Scrap : Waste of materials arising in the course of manufacturing as well as spoiled or defective
materials are called scrap.
7. Work – in – Progress : The goods still in the process of being manufactured, on which some
process is partly done are work-in-progress.
8. Defective work : It is that product which contains a manufacturing defect and cannot be sold
without correcting such defects.
MATERIAL CONTROL:
Material control is a systematic check over procurement, storage and consumption of materials so
as to ensure minimum wastage, flow of materials and minimum investment in inventories.
Material control covers following four aspects -
1. Control over purchases,
2. Control over Receipts
3. Control over Storage

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

4. Control over Consumption

OBJECTIVES OF MATERIAL CONTROL


1.Adequate stock
2.Minimize Inventories
3.Maintaining Continuity of Production
4.Minimize cost of purchasing and storage- cost of placing frequent orders is heavy but at the same
time it saves lot of expenditure on storage cost, insurance, interest, etc.
5.Reduce wastage and losses – excessive inventory – risk of goods stolen or will deteriorate
6. Minimize risk of obsolescence
7.Effective use of funds – various level of stock
8.Assisting purchase of materials
9.Giving maximum satisfaction to customers
10.Reducing loss due to fall in price
11.Maximum use of space
12.Proper storage – it aim at storage of hundreds of items of materials and parts. This ensures that
necessary material is available easily when required.

CONTROL OVER PURCHASE OF MATERIALS :


1.Accurate estimate of requirements – The purchase officer receives instructions to purchase
materials either from Planning department or from store keeper or from production department.
2.Determining features and quantities of materials – size, colour,weight, brand etc.
3.Bill of Materials : Where planning department exists, it prepares a statement showing
requirements of materials for each order or batch of production. This statement is called Bill of
Materials.
4.Purchase Requisition: The purchase is initiated by the purchase officer on receiving Purchase
Requistion from store keeper or head of production department.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

PURCHASE REQUISITION
Sr. No.____________ Date. __________
Please arrange to purchase the following:
Name of Department ________ Production order No. _______
Date by which materials
Are required ________ Present Stock _____________
Rate of Consumption _________

No. Code No. Description Quantity Remarks


Required
Purchase order No. ____________ Order placed with ____________
Ordering Date ____________ Delivery Date _______________
Approved by ________________

_______________

( Purchase officer)

5. Schedule of Quotation:
On the receipt of purchase requirement/requisition, the purchase department would invite tenders
or quotations for the supply of goods. After the receipt of quotations, the purchase department will
make the schedule of quotations for the selection of a supplier, keeping in mind all the required
considerations such as price, quality, and terms of payment, reliability of supplier, mode and time
of delivery.
6. Purchase Order:
After selecting the supplier, the Purchase Department proceeds to prepare a purchase order. On
the basis of purchase order, supplier will supply the goods.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

PURCHASE ORDER
To Messers____________ No. __________
Date __________
Our Ref. ______________
Please supply the following items of materials in accordance with the instructions mentioned here in.

Description Quantity Rate Unit of Price Delivery date Other terms

To be delivered at ____________ ____________

Terms of payment _______________ Signature

7. Order register :
It is maintained by the purchase department to record all details of purchase order. For each type
of material, a separate page is kept. In such register, details about the date of order, number,
quantity, price, delivery date and other terms are entered.
RECEIPTS AND INSPECTION OF GOODS
1.Recording receipt of goods:
The stores department will receive the material after the gate entry. It will compare the quantities
received with the PO Quantity. It is a valuable document as it forms the basis of accounting entry
in the stores ledger and stock records. It is the document basis for quality control department to
carry inspection of the material inwarded. It also forms the basis of payments to be made to the
supplier in respect of the materials supplied by him. Suppliers invoices are checked with goods
received notes which such for actual receipt of the goods supplied by the supplier. One copy of
such note is also sent to Inspection Department who after inspection of materials approves the note
for Stores Department to receive the materials.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

GOODS RECEIVED NOTE


No. _________ Date _________________
From ________ (Vendor) Order No. _____________
Date of the order ________

Serial No Description Symbol Quantity Rate Supplier Charges Total

Received by ________ Bin card No. ___________ Store keeper _______


Inspected by _______ Stores L.F.No. __________ Invoice No. _________

2. Inspection of Quality
3. Sending Goods to Store keeper
4. Procedure of Costing section
5. Examining the Invoice – supplier sends his invoice to purchase department, which would
compare the details of the invoice with the copy of the purchase order.
6. Sanctioning payment- Accountant receives the invoice from the purchase office and a copy of
Goods Received Note from the store keeper. He compare details of these two and also those
mentioned in the purchase order.
7. Goods return order – If certain goods are not accepted due to certain reasons, a Goods Return
order is prepared.From this order the Accounts department will return the invoice to the supplier.
Notes: Three copies of goods received note – storekeeper, costing department and accountant
ISSUE OF MATERIALS
1.Issue by Authorised Requisition (Material Requisition):
Material Requisition is an authority to storekeeper to issue raw materials or other stores. Generally,
the foreman of the department requiring the raw material is authorized to sign such materials
requisition and for that blank forms are supplied to each department.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

MATERIAL REQUISITION
No. _________ Job No._________________
Date ________ Job L.F. No. _____________
Bin No ________

Size Weight No Description Symbol Stores Ledger Rate Amount

Authorized by ________ Received by _______


Stores keeper’s sign _______ Checked by _________

2. Stores debit note for materials returned:


When materials issued may be in excess of the requirement and have to be returned to the stores.
So materials are returned alongwith Stores Debit Note to the store-keeper.

3. Material Transfer Note


Sometimes materials may have to be transferred from one job or department to another job or
department. So in such a case, the Material Transfer Note should be prepared by the transferring
department for getting material.

MATERIAL TRANSFER NOTE


No._______ Issuing Dept. _________
Date __________ Receiving Dept. _______

Quantity Description Code No. Rate Amount Remarks

Authorised by ____________ Calculation by __________


Transferor _______________ Stores Ledger by ________
Received by ______________ Job Ledger by __________

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

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

BIN CARD
Bin No. _________ Stores L.F.No.________________
Symbol ________ Maximum level ______________
Description ______ Minimum level _______________
Ordering level _______________
Receipt Issue Balance
Date Ref. Quantity Date Req. No Quantity Quantity Checked by

STORES LEDGER
The cost office maintains a store ledger in which separate card is maintained for each type of raw
material and spare parts in the store. Stores ledger gives the same information as is available in the
bin cards except that it gives the monetary information also, such as the rate, amount of receipts,
issues and the balance of materials. So the stores ledger account has three broad sections – receipts
with quantity, rate and amount, issues with quantity, rate and amount and balance with quantity,
rate and amount.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

STORES LEDGER
Type _________ Symbol________________
Grade ________ Maximum level ______________
Location ______ Minimum level _______________

Receipt Issue Balance


Date Ref. Quantity Rate Amt Date Req. Quantity Rate Amt Quantity Rate Amt
No

INVENTORY VALUATION OR STOCK TAKING


BASIS PERIODIC INVENTORY PERPETUAL INVENTORY
Meaning It is a system of physical stock It is a system of continuously
taking at the end of a year or at comparing Bin card with store
convenient time . ledger records.
Staff General staff Trained and experienced staff
Corrective steps As the wastage, shortage, As stock taking is done
misappropriation etc. are known continuously, such wastage is
only at the end of the year, there comes to the notice and it is
is less scope for taking possible to take corrective steps
corrective steps.
Production work Production work is interrupted at Production work is not interrupted
the time of stock taking as checking is done continuosly
Expensive Less expensive More expensive
Moral Check No moral check on the staff Moral check on the staff of stores
department is maintained.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Accuracy & Less accurate & reliable More accurate & reliable
Reliability
Preferred by Small enterprises Large enterprises

METHOD – 1
ORDERING QUANTITY OR EOQ
The economic order quantity is the optimum quantity of an item to be purchased at one time in
order to minimize the combined annual costs of ordering and carrying the item in inventory.
The quantity of order for which order must be placed or packing in which the material is generally
available in the market. Eg. If a particular chemical is available in packing of 100 kgs. Or its
multiple only, then an order for at least 100 kgs must be placed. So here ordering quantity is 100
kgs.

EOQ =

Where:
EOQ = Economic Order Quantity
A = Annual demand/ consumption or requirement of the material in units
O = Ordering cost per order
C = carrying cost or cost of carrying inventory per year
Note: If the carrying cost is given in percentage, then (P) or the price per unit is put in the
denominator in the above formula.

EOQ =

Where:
P = Price per unit/ cost / selling price
Ordering cost : It is the cost of placing an order and securing the goods. Eg. Administrative cost,
telephone charges, delivery charges

Inventory carrying cost or cost of holding inventory: It includes interest on investment, loss
due to outdated, storekeeping cost, insurance premium, transportation cost, etc.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Ex.1 Find out EOQ.


Total Annual consumption = 10,000 kgs
Cost of carrying inventory = 10%
Ordering cost = Rs.8
Purchase price per kg. = 40 paise (GU -March,2006)

Ex.2 EOQ = 200 units


Cost of placing an order = Rs.100
Annual carrying cost = 10%
Price per unit = Rs.130
Calculate: (1) weekly consumption of materials (2) Number of order to be placed in the
year.b(SGU, April,2009)
Ex.3 Calculate EOQ.
Annual consumption = 10,000 units
Cost per unit = Rs.8
Insurance cost per unit = Rs 0. 60
Interest expenses per unit = Rs. 0.20
Storage expenses per unit = Rs. 0.20
Cost per order = Rs. 25 (NGU, March,2007)
Ex.4 About 50 items are required daily for machine. Cost of placing an order is Rs. 50. Carrying
cost per day per item is Rs.0.02. Find out EOQ. (GU, March,2006)
Ex.5 ABC manufacturing using materials of Rs. 50,00,000 p.a. Cost of administrative expense is
Rs. 50 per order. Transportation cost is 20 % of the average stock. Find out EOQ.
Ans:
A = Rs. 50,00,000
O = Rs.50
C = 20% (SGU, 1997)
Ex.6 Find out EOQ from the following information.
Annual consumption = 10,000 units
Purchasing cost per unit = Rs.50
Cost per order = Rs.1000

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Carrying cost per order = 10%


Ex.7 Calculate EOQ.
Annual consumption = 120 units
Cost of placing an order = Rs.20
Cost per unit = Rs.100
Carrying cost = 3%
Ex.8 Calculate EOQ and find out how many times during the year order should be placed.
Bi – monthly consumption = 600 units
Cost of placing an order = Rs.1000
Carrying cost = 5%
Selling price per unit = Rs.400 (SGU, May,2006, Nov,2014)
Ex.9 Find out EOQ. From the following information.
Tri – monthly consumption = 900 units
Cost of placing an order = Rs.1000
Carrying cost = 5 %
Cost price per unit = Rs.400
Ex.10 Find out from the following information.
1. EOQ
2. Number of orders per annum
3. Time taken between two orders
The annual demand for a product is 6,400 units. The per unit cost is Rs.6 and inventory carrying
cost per unit per annum is 25 % of average stock. The cost of procurement is Rs. 75. (Sau Uni,
Nov,2011)
Ex. 11 The following details regarding materials is obtained from ledger of a company. Find out
the cost per unit. (P)
EOQ = 1000 units
Annual consumption = 2500 units
Carrying cost per unit = 10%
Cost of placing an order = Rs.200
Ex-12. EOQ = 1,500 units, Price per unit = Rs.10, Order cost per order = Rs.30, Carrying cost per
unit Rs.1

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Find out :
1.Usage per annum
2.No of orders per year
3.Time lag between two orders (SGU, April, 2012)
METHOD -2
SETTING STOCK LEVELS
To reduce the cost of materials to minimum, there should not be over investment in materials.
Similarly, the production should not be held up for want of materials. So, the stores control
demands that the minimum level of stock should be fixed below which stock should not fall, the
maximum level should be fixed beyond which the stock should not rise and ordering level should
also be fixed when the steps should be taken to place the order.

1. Maximum level
It is the quantity of stock on hand at any time, beyond which it should not be allowed to
rise.
Maximum level = Ordering level – (Minimum consumption *
Minimum time ) + Ordering quantity (EOQ)
2. Minimum level
The quantity of material below which it should not be allowed to fall is the minimum level.
Minimum level = Ordering level – (Average consumption *
Average time)
3. Ordering level
It is the level of stock at which it becomes necessary to place an order for fresh supplies of
materials.
Ordering level = Maximum consumption * Maximum time
4. Danger level
It is the level of stock below the minimum level.
Danger level = Average consumption * Maximum delivery
time for emergency purchase

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

5. Safety stock
When long time is required to receive raw materials or parts from suppliers it would be
desirable to keep safety stock so that production is not interrupted.
Safety stock = Maximum consumption * (Maximum time –
Average time)
6. Average Stock level = Minimum level + ½ EOQ
OR
Average Stock level = Minimum level + Maximum level
2
Method – 2 Examples on Setting Stock Levels
Ex.1 Normal consumption (Average consumption) = 125 units per day
Maximum consumption = 140 units per day
Re-order period = 35 to 55 days
EOQ = 500 units
Find out 1. Ordering level 2. Maximum level 3. Minimum level
Ex.2 Maximum delivery period = 90 days
Average delivery period = 70 days
Maximum delivery period for emergency purchase = 10 day
Maximum rate of consumption per day = 60 units
Minimum rate of consumption per day = 40 units
Ordering quantity = 1200 units
From the above information, find out 1. Ordering stock level 2. Minimum stock level 3. Average
stock level 4. Maximum stock level 5. Danger stock level
EX.3 From the following data of the Shree Krishna Ltd. Find out -
1. Ordering level 2. Maximum level 3. Minimum level 4. Average stock level 5. Danger level 6.
Safety level
Maximum time for emergency purchase = ½ weeks
EOQ (Ordering Quantity) = 1200 units
Particulars Maximum Average Minimum
1.Re-order period (weeks) 5 ? 3
2.Usage (Consumption) ? 70 60

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Ex.4 Vipul Ltd. uses different types of materials A,B, C & D, in respect of which following
information is available. Find out
1. Minimum level of A 2. Maximum level of B 3. Safety stock of C 4. Ordering level of D
Particulars A B C D
Delivery time (Weeks) 3 to 4 4 to 5 6 to 7 7 to 8
Average consumption (weekly) ? 40 70 250
Maximum consumption (weekly) 55 45 ? ?
Minimum consumption (weekly) 45 ? 40 200
EOQ (units) ? 50 ? 100
Ex. 5 From the following information of Prerna Ltd. find out 1. EOQ 2. Ordering level 3.
Maximum level 4. Minimum level 5. Safety stock
Annual consumption = 12000 units
Cost per unit = Rs. 1
Cost per order = Rs.12
Inventory carrying cost = 20% p.a.
Lead time (Maximum – Average – Minimum) (30-15-5 days)
Daily consumption = (45 – 33 – 15 units)
Maximum time for emergency purchase = 5 days
Ex.6 From the following information of Desai Company Ltd. find out :
1.Reordering level 2.Minimum level 3.Maximum level 4.Danger level 5. Safety level
Maximum procurement time = 55 days
Maximum time for emergency purchase = 5 days
Average time = 50 days
Minimum daily consumption = 1200 units
Average daily consumption = 1500 units
EOQ = 25% of ordering level
Ex.7 A company uses 3 raw materials A,B & C for a particular product for which the following
data apply.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Raw Usage per Re- Price per Delivery period (weeks) Reorder Minimu
Material unit of order kg Rs. level kgs m level
product Qty kgs
(kgs) (kgs)
Mini Ave. Maxi
A 10 10,000 0.10 1 2 3 8,000 -
B 4 5,000 0.30 3 4 5 4,750 -
C 6 10,000 0.15 2 3 4 - 2,000

Weekly production varies from 175 to 225 units, averaging 200 units of the said product, what
would be the following quantities ?
1. Minimum stock of A 2. Maximum stock of B 3.Reorder level of C 4. Average stock of A

METHOD -3
INVENTORY TURNOVER RATIO / MATERIAL TURNOVER RATIO / STOCK
TURNOVER RATIO
In order to find out the speed of movement of a particular item of material, the inventory turnover
rate is calculated. The purpose of the ratio is to ascertain the speed of movement of a particular
item. A high ratio indicates that the item is moving fast with a minimum investment involved at
any point of time. On the other hand a low ratio indicates the slow moving item. Thus Inventory
Turnover Ratio may indicate slow moving dormant and obsolete stock highlighting the need for
appropriate managerial actions.
Steps for solving the example:
1. Material consumed / Cost of goods sold / Consumption of material / Adjusted purchase =
Opening stock + Purchase – Closing stock
2. Average stock = Opening stock + Closing stock
2
3. Inventory Turnover Rate = Consumption of Material
Average stock
4. Inventory Turnover in days = Days / Inventory Turnover Ratio

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Ex.1 From the following information find out, Material Turnover Rate and Turnover period.
Opening stock = Rs. 20,000
Closing stock = Rs. 50,000
Purchases = Rs. 1,70,000
Ex.2 Calculate Material Turnover Rate and Period.
Purchases = Rs.2,50,000
Opening stock = Rs.12,500
Closing stock = Rs. 25,000
Stock is valued on the basis of cost + 25%
Ex.3 From the following information, find out Material Turnover Rate:
Year Sales Rs. Opening stock Rs. Purchases Rs.
2015 – 16 4,50,000 75,000 3,00,000
2016 – 17 7,50,000 - -

Rate of Gross Profit = 33 1/3 % of the cost. Closing stock = 12.5 % of purchase.
Find out Material Turnover Ratio for 2015-16 and opening stock of 2016 -17.
Ex.4 From the following information for the year 2018, calculate Inventory Turnover Ratio and
Turnover Period.
Particulars Materials A Materials B
Opening stock 40,000 80,000
Purchases 1,30,000 2,00,000
Closing stock 20,000 40,000

Ex.5 Calculate 1. Closing stock 2. Consumption of Materials 3. Material Turnover Rate


Opening stock = Rs. 35,000
Purchases = Rs.95,000
Average stock = Rs. 30,000
Ex.6 From the following information, find out purchases.
Opening stock = Rs.1,00,000 , Average stock = Rs. 1,40,000
Inventory Turnover Ratio = 4 times

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Ex.7 The following information is received for the Atul Ltd. for the year 2018 & 2019.
Particulars 2018 2019
Purchases 2,70,000 ?
Average stock 50,000 70,000
Opening stock 40,000 60,000
Stock Turnover Rate ? 10 times

From the above information, find out 1. Stock Turnover Rate and COGS for the year 2018. 2.
Purchases and COGS for the year 2019.
Ex.8 Calculate Material Turnover Rate and Period.
1. Purchases =Rs. 5,00,000
2. Closing stock is ½ of the opening stock
3. Opening stock = 25,000 units, per unit Rs.2
4. Stock is valued on the basis of cost plus 25%
Ex. 9 From the following information, find out purchases.
Inventory Turnover Rate = 3
Average stock = Rs.15,000
Closing stock was double the amount of opening stock.
Ex.10 Following is the information for 2018 and 2019.
Particulars 2018 2019
Average stock ? 40,000
Opening stock 40,000 ?
Purchases 2,07,000 ?
Adjusted purchases 2,05,000 ?
Turnover rate ? 4.5 times
From the above data, find out Material Turnover Rate and period for 2018 and Purchases and
Adjusted purchases for 2019.
ABC SYSTEM OF STORES CONTROL:
The “ABC Analysis” is an analytical method of stock control which aims at concentrating efforts
on those items where attention is needed most. It is based on the concept that a small number of
the items in inventory may typically represent the bulk money value of the total materials used in

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

production process, while a relatively large number of items may present a small portion of the
money value of stores used resulting in a small number of items be subjected to greater degree of
continuous control. Under this system, the materials stocked may be classified into a number of
categories according to their importance, i.e., their value and frequency of replenishment during a
period.
The first category (we may call it group ‘A’ items) may consist of only a small percentage of total
items handled but combined value may be a large portion of the total stock value.
The second category, naming it as group ‘B’ items, may be relatively less important.
In the third category, consisting of group ‘C’ items, all the remaining items of stock may be
included which are quite large in number but their value is not high.
Category No of items (%) Value (% of total inventory)
A 10 % 75 %
B 25 % 20 %
C 65 % 5%

Advantages:
1. Relives stores department of unnecessary work and concentrate on more important work.
2. Provides data for giving more attention to few costly items and less attention to cheap items.
3. Increases efficiency, which resulted into increase in profitability.
4. To use principle of exception – the storekeeper can give more attention to important items.
5. If this method is not used, the controlling efforts will be spread on all materials equally. So more
attention is given to even less important materials also. So such situation is avoided here.
6. Helps in reducing theft, wastage, misuse of material.
7. Overstocking of costly item is not done. So it saves a lot of expenses like cost of storage,
insurance premium, clerical cost, interest on capital etc.
SOME IMPORTANT TERMS OF MATERIALS:
1.Wastage of Materials:
(i) Normal Wastage: Certain wastage is unavoidable due to the nature of materials . Eg. Some
weight is lost due to evaporation. Such losses are inevitable and cannot be reduced beyond a
particular limit. The percentage of such wastage is predetermined in Industry. As it is unavoidable,
even insurance companies do not insure it. Such wastage is termed as normal wastage.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

(ii)Abnormal wastage: The wastage which is avoidable is called abnormal waste. It arises due to
carelessness, theft, fire, inefficient storage etc.Value of abnormal loss should be charged to Costing
Profit & Loss a/c.
2.Scrap :
When during the manufacturing process, there is some left-over of raw materials, which can not
be used for any other purpose, it is treated as scrap and is sold away without any further processing.
Eg. Gold dust in jewellery , waste of wood pieces in making furniture.
3.Spoilage :
When the raw material is so damaged during manufacturing process that it has to be taken out from
the process and has to be sold without further processing, then it is called spoilage. Sometimes,
spoilage can be sold in the market as ‘seconds’.
4.Defectives :
If the spoiled units can be corrected by further processing, they are called defectives. They are the
goods turned out during production, which has to be re-processed, before they can be sold.

CHAPTER – 3 MATERIALS ACCOUNT – 2

METHODS OF PRICING ISSUES:


The problem of pricing the issues arises only when large quantities of materials purchased at
different prices remain in the stock for a period of time making it difficult to identify which unit
of material was purchased at what price and hence which price is to be charged for which issue.
The pricing of issues only deals with the assigning of pricing to the issues.
FIRST IN FIRST OUT (FIFO):
Under this method, issues are priced on the assumption that materials purchased first are issued
first. The actual physical movement may or may not follow this pattern. Materials issued are priced
at the oldest price recorded in stores ledger for materials in stock. So the closing stock of material
is valued at the price of the latest purchases.
The method is particularly suitable in case of perishable materials and in the period of falling
prices.
Advantages:
1. Most suitable in Perishable product as pricing method more on less corresponds with actual
movement of Materials.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

2. Simple to understand.
3. All issues are priced at cost price, hence entire cost of materials are recovered.
4. The value of closing stock is realistic as it is valued at the price of latest purchases.
Disadvantages:
1.The issue price differs for different issues of the same quality of raw material at the same time.
Therefore cost comparisons get distorted.
2.During the period of rising prices, it results in higher book profits and therefore high tax liability.
This is because closing stock appearing on the credit side is valued at higher prices and the cost of
production appearing on the debit side is valued lower prices.
LAST IN FIRST OUT (LIFO):
Under this method, issues are priced on the assumption that material purchased last are issued first,
though the actual physical movement of materials may not follow this pattern. Issues are priced at
the price of latest purchases of materials remaining unissued at per records. As a result the closing
stock gets priced at the price of the earliest purchases of materials lying unutilized as per records.
The method is particularly useful in the case of rising prices. The production is charged at the price
of latest purchases while the closing stock at the earliest prices which are lower. This leads to lower
book profit and hence less tax liability. In case of falling prices the effect is reverse.
Advantage:
1. Method gives good matching of sales and cost of sales.
2. Method is simple to understand.
3. Issues are priced at cost and hence entire cost of material used is recovered from production.
4. It results in lower book profits and hence lower tax.
Disadvantages:
1.The issue price differs in different issues and hence distorts cost comparison.
2. During the period of falling prices this method gives high profits and higher tax liability.
WEIGHTED AVERAGE METHOD
For eliminating effects of price fluctuations, an average price method is used. There are two types
of Averages.
1.Simple Average:
It is the average of prices at which various lots of materials are purchased, without taking in to
consideration the quantity purchased.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Eg. One lot of 200 kgs material A is purchased at Rs.15 per kg. and 600 kgs are purchased at Rs.16
per kg. So, the simple average will be Rs.15 + Rs.16 = Rs.31/2 = Rs.15.50 per kg.
2.Weighted Average method :
It is obtained by dividing the total value of stock by the total quantity. The average will have to be
calculated afresh, every time fresh supply arrives.
Eg. 200 kgs are purchased on 5/2/19 at Rs. 15 per kg. and 600 kgs on 8/2/19 at Rs. 16 per kg. then
the weighted average price will be calculated as under:

Weighted Average = p1q1 + p2q2


q1 + q2
= (15*200) + (16*600)
200 + 600
= 3,000 + 9,600
800
= Rs.15.75
Where, q1 = Quantity of first purchase, q2 = Quantity of second purchase
P1 = Price of first purchase , P2 = Price of second purchase
Advantages:
1.As both quantity and value are taken into account, the value of goods issued will be reasonable.
2.If there are wide or frequent fluctuation in prices, then its effects will be reduced under this
method, because average price reduces the effect of differences in prices.
3.Under LIFO and FIFO methods in the same issue – certain goods are charged at one price and
certain other goods are charged at different prices. However, in weighted average method, the
same issue of goods are priced at one price only.
Disadvantages:
1.If there are frequent purchases, then calculation becomes complicated.
Highest-in First-Out (HIFO) Method:
Under this method, the materials with highest prices are issued first, irrespective of the date upon
which they were purchased. The basic assumption is that in fluctuating and inflationary market,
the cost of material are quickly absorbed into product cost to hedge against risk of inflation. This
method is used when the material is in short supply and in execution of cost plus contracts.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

Fixed Price Method:


In case of certain items of stores, of which the prices do not fluctuate much, the issues are priced
at a fixed price. Adjustment in such prices may be made, if prices have fluctuated beyond a
reasonable limit.
Standard Cost/ Price Method:
Under this method, material issues are priced at a predetermined standard issue price. Any variance
between the actual purchase price and standard issue price is written off to the Profit and Loss
Account. Standard cost is a predetermined cost set by the management prior to the actual material
costs being known and the standard issue price is used for all issues to production and for valuation
of closing stock.
Inflated Price Method:
Where there is an inevitable wastage due to inherent qualities of material, such normal wastage
must be recovered from cost of production. So, the price at which material charged is increased,
so as to cover the cost of wastage.
Eg. 1,000 kg of materials is purchased at Rs.18 per kg and total cost Rs.18,000. If 10% is the
normal wastage then only 900 kg will be used in production. So, the total cost of Rs.18,000 will
be spread over 900 kgs. So issues of material will be priced at Rs.20 per kg.
Replacement Cost Method:
This method is also called as ‘market price method’. In this method, issues are priced at a price
ruling in the market at the time of issue. So cost will conform to the latest market conditions. The
value of closing stock would show the actual cost which indicates market price prevailing on that
date.
Base Stock Method:
Under this method, a specified quantity of material is always held in stock and is priced at its
original cost as buffer or base stock; and any issue of materials above the base stock quantity is
priced under any one of the methods discussed above.
EXAMPLES ON FIFO, LIFO AND WEIGHTED AVERAGE

EX.1. The following are the transactions of receipts and issues of an item of raw material.

Date & Year Particulars Units Price Per Unit


Rs.

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SYBCOM-SEM-3 ADVANCED ACCOUNTING AND AUDITING-1 (DR. HIRAL DESAI (PH.D. (COMMERCE),
MBA (FINANCE), M.COM.)

2018
March – 1 Purchases 600 1.5
March – 4 Purchases 1,200 2.00
March – 6 Issued 1,000 -
March – 10 Purchases 1,400 2.00
March – 15 Issued 1,600 -
March – 20 Purchases 600 2.5
March – 23 Issued 200 -

EX.2. The following are the transactions of receipts and issues of an item of raw material.

Date & Year Particulars Units Total Amt. Rs.


2019
July – 1 Purchases 250 750
July – 8 Purchases 250 1,000
July – 13 Issued 200 FIFO
July – 15 Purchases 500 2,500
July – 21 Issued 300 LIFO
July – 23 Purchases 300 1,500
July - 30 Issued 400 WEIGHTED
AVERAGE

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