MATERIALS

Points to be covered:

Economic Order Quantity (EOQ)

Different Level of Materials

Valuation

Material Control (ABC Analysis)

Material Losses

Optimum Run Size

Economic Order Quantity

Economic Order Quantity (EOQ) is the quantity to be Ordered at a time such that Total
Cost is minimum.
EOQ is a concept of decision making , so we are to consider only the Relevant Cost.
Consideration of relevant cost of EOQ
EOQ is a concept of decision making , so we are to consider only the Relevant Cost.
Following are the Relevant Cost with respect to Materials.

Purchase Price.

Ordering Cost.

Carrying Cost.

Purchase Price:
It is the cost incurred with every unit purchased.
If purchase price per unit is constant then, it would be considered as an
irrelevant cost for EOQ.
Ordering Cost:
It is the cost incurred with every order placed.
Total Ordering Cost = Number of Orders Cost per order
(Note: Cost Per Order will always remain constant.)

Carrying Cost:
Carrying costs are the costs which varies with every unit stored.
Eg. :

i. Interest on Investment (on inventories).

ii. Insurance Premium.
iii. Rent (if it is based on no. of units stored).

Total Carrying Cost = Average Inventory Carrying Cost per order

Here ,
Avg. Inventory = Quantity Ordered 2
Economic Order Quantity

EOQ = (2AO/Ci)
A = Annual Consumption.
O = Ordering Cost Per Unit.
C = Carrying Cost (incremental) of one unit of inventory for 1 year.
Assumptions for EOQ
1. Consumption Pattern is uniform.
2. Purchase Price per unit is constant.
(i.e. there is no quantity discount)
3. Cost per order is constant.

Special Note on Ordering Cost:

For calculating Total Ordering Cost, No. of orders can be in fraction.
But if the answer is to be given in No. of orders it should not be in fraction.
We have to Round it off either in the Lower side or the Upper side depending upon
the stock position.

Relationship Between Ordering & Carrying Cost

SL
NO.

Quantity /
Order

No. of
Orders

Ordering
Cost

Avg.
Inventory

Carrying
Cost

1.

High

Low

Low

High

High

2.

Low

High

High

Low

Low

Different level of inventories

i) Re-order Level
The level of inventory where fresh order for purchase of Raw materials is to be placed is
called Re-order Level.
ROL = Maximum Delivery Time Maximum Consumption.
=Safety Stock + Average Lead Time Consumption.
Note: Re-order Level does not have any unique formula.
ii) Maximum Level:
(ROL+ROQ)-(Minimum Delivery Time Minimum Consumption Period)
iii) Minimum Level:
ROL (Average Delivery Time Average Consumption)
iv) Average Level:

Maximum Level + Minimum Level

2
Or,
Minimum Level + EOQ

v) Danger Level:
Emergency Delivery Time Average Lead Time Consumption

Effect of ROL on Carrying & Stock Out Cost

SL
NO.

ROL

Carrying cost

Stock out Cost

1.

High

High

Low

2.

Low

Low

High

Valuation of Stock:
All Cost incurred for increasing the value of goods are to be included in valuation.
(Creation of time, place and form utility).
Treatment of Normal Loss:
Normal loss is to be treated like cost and any cost is to be included as per above rule.
So, if normal loss is during creation of utility then we will reduce the number of units to
increase the cost per unit.
Treatment of Abnormal Loss:
Abnormal loss is not be treated as cost.
ABC Analysis
Category

Value

Variety

Control

70%

10%

High

B(Remaining)

20%

20%

Moderate

10%

70%

Least

Types of Material Losses:

Waste.

Scrap.

Spoilage.

Defective.

Material Losses:
1. Waste:
Discarded material having no realizable value.
Accounting Treatment:
If wastage is normal, Loss is to be treated as cost and if it is abnormal, transfer it to P/L.
2. Scrap:
Discarded material having realizable value.
Accounting Treatment:
Scrap is generally normal, realizable value from scrap can be reduced from cost, or it can
also be treated as other income.
3. Spoilage:
Damaged units of production that cannot be rectified economically.
Accounting Treatment:
Loss on spoilage if normal should be treated as cost, if abnormal it should be charged to
P/L.
4. Defectives:
Damaged units of production which can be rectified and can be converted into good units.
Accounting Treatment:
Loss on spoilage if normal should be treated as cost, if abnormal it should be charged to
P/L.

Optimum Run Size

Optimum Run Size is the quantity to be
minimum.

produced at a time such that Total Cost is

Optimum Run Size = (2AO/Ci)

Where, A = Annual Demand.
O = Cost Per Run.
Ci = Carrying Cost (incremental) of one unit of inventory for 1 year.
Bin Card:
Bin card is a document, card or sheet attached to each bin of materials prepared by the
store-keeper for quantitative recording of the material received, issued and instance
balance in store.
Separate bin cards are maintained by the store-keeper for each item of materials and are
placed in shelves or bins or are suitably hung up as convenient alongside the materials in
storehouse.
Advantages of Bin Card:
1) There would be fewer chances of mistakes being made as entries will be made at the
same time as goods are received or issued by the person actually handling the
materials.
2) Control over stock can be more effective, in as much as comparison of the actual
quantity in hand at any time with the book balance is possible.
Disadvantages of Bin Card:
1) Store records are dispersed over a wide area.
2) The cards are liable to be smeared with dirt and grease because of proximity to
material and also because of handling materials.
Stock Control Card:
These cards are similar to bin cards, which maintain quantitative records of stores. The
only difference is that it provides an additional information, i.e., stock on order.
Bin cards are kept attached to the bin or receptacles for identification of stock, whereas
Stock Control Cards are kept in cabinets or trays or loose binders.

Advantages of Stock Control Card:

1) Records are kept in a more compact manner so that reference to them is facilitated.
2) Records can be kept in a neat and clean way by men solely engaged in clerical work
so that a division of labour between record keeping and actual material handling is
possible.
Disadvantages of Stock Control Card:
1) On the spot comparison of the physical stock of an item with its book balance is not
facilitated.
2) Physical identification of materials in stock may not be as easy as in the case of bin
cards, as the Stock Control Cards are housed in cabinets or trays.
Perpetual Inventory Records:
A perpetual inventory is usually checked by a programme of continuous stock taking.
Continuous stock taking means the physical checking of those records (which are
maintained under perpetual inventory) with actual stock.
Perpetual inventory is essential for material control. It incidentally helps continuous stock
taking.
JIT Purchases:
Just in time (JIT) purchases means the purchase of goods or materials such that delivery
immediately precedes their use.
Advantages:
a) The suppliers of goods or materials co-operates with the company and supply
requisite quantity of goods or materials for which order is placed before the start of
production.
b) JIT purchases results in cost savings for example, the costs of stock out, inventory
carrying, material also handling and breakage are reduced.
c) Due to frequent orders of raw materials, its issue price is likely to be very close to
the replacement price. Consequently the method of pricing to be followed for valuing
material issues becomes less important.
Objectives of a system of Material Cost Control:
1. Purchasing raw materials of the required quality, neither inferior nor highly
superior.

2. Negotiating best prices for raw materials, from suppliers taking factors like quality,
timeliness, reliability into account.
3. Making available all items of materials, stores & consumables, at the right time, so
as to ensure smooth production flow.
4. Holding stocks of the required quantity by avoiding overstocking & stock outs, &
thereby minimizing total associated cost i.e. ordering costs carrying costs.
5. Avoidance of unnecessary losses and wastages that may arise from deterioration in
quality due to defective or long storage or from obsolescence.
6. Proper accounting of material costs for reporting decision making, planning &
control purpose.
Purchase Requisition:
A purchase requisition is a form used for making a formal request to the purchasing
department to purchase materials.
This form is usually filled up by the store keeper for regular material and by the
departmental head for special materials (not stocked as regular items).
The requisition form is duly signed by either works manager or plant superintendent, in
addition to the one originating it.
Bills of Materials:
A bill of materials is a list of the raw materials, sub-assemblies, intermediate assemblies,
sub-components, parts and the quantities of each needed to manufacture an end product.
Materials Requisition Note:
A material requisition note lists the items to be picked from inventory and used in the
production process or in the provision of a service to a customer, usually for a specific job.
Bills of Materials v/s Material Requisition Note:
Bills of Materials

Material Requisition Note

1. It is a document by the drawing 1. It is prepared by the foreman of the

office.
consuming department.
2. It is a complete schedule of 2. It is a document authorizing
component parts and raw materials storekeeper to issue material to the
required for a particular job or work consuming department.
order.

3. It often serves the purpose of a store 3. It cannot replace a bill of material.

requisition as it shown the complete
schedule of materials required for a
particular job i.e. it can replace stores
requisition.
4. It can be used for the purpose of 4. It is useful in arriving historical cast
quotation.
only.
5. It helps in keeping a quantitative 5. It shows the material actually drawn
control on materials draw through from stores.
stores requisition.

Continuous Stock Verification:

The checking of physical inventory is an essential feature of every sound system of material
control.
Such a checking may be periodical or continuous.
Periodic Stock Verification:
Periodic stock verification is usually undertaken for regular, inexpensive items. The term
'Periodic' generally refers to annual stock count.
However, periodic may also refer to half yearly, Quarterly, monthly, bi-monthly or daily.
Inherent Shortcomings of Periodic Stock Verification:
1. Since all the items have to be covered in a given number of days, either the
production department has to be shut down during those days to enable thorough
checking of stock or else the verification must be of limited character.
2. In periodical checking there is the problem of finding an adequately trained
contingent. It is likely to be down from different departments where stock-taking is
not the normal work and they are apt to discharge such temporary duties somewhat
perfunctorily.
3. Element of surprise, is wholly absent in the system.
4. If there are stock discrepancies, they remain undetected until the end of the period.