Introduction
Commodities which are used in the production of the finished product are called materials. All those items, which are used in the process of producing goods or rendering services, are called materials. It includes all raw materials and supplies like lubricants, fuel, and lost tools. Sometimes materials are also denoted by the term inventory of stores.
Materials are of two
types as direct and indirect materials
Direct materials:
Direct materials cost
means the cost of materials that can be identified with and allocated to cost
centers or cost units. The cost of paper used to print textbook is direct cost
since it is the main input of the textbook. Thus, the main raw materials and
necessary components are a few examples of direct materials.
Indirect materials:
Indirect materials
cost refers to the material costs, which cannot be allocated but can be
apportioned to or absorbed by cost centers or cost units. The cost of materials
incurred for repair or a machine used for printing of text is defined as indirect
materials cost. Fuel, lubricating oil, materials used for repair, coal,
maintenance work, etc. are a few examples of indirect materials.
Material control
The systematic and
regular control over purchasing, storing, and consumption of materials is
material control. Material control involves planning, operating, organizing,
and controlling the purchasing, storing, and using materials to achieve the
objectives of minimizing the possible cost of materials and uninterrupted
production. In other words, it is a system, which helps to provide the right
quality of materials in the right quantity at the right time and right place
with the right amount of investment. Effective control also requires the systematic
preparation of periodic summaries and reports. It can be defined as a
systematic control over purchasing, storing, and consumption of materials. It
helps to maintain a regular and timely supply of materials by avoiding over and
understocking.
Need for materials
control
Materials control is
necessary for making an efficient purchase, storing, and consumption of
materials. Every manufacturing company requires to maintain a materials control
system that facilitates the efficient purchase, storage, and use of the
materials. Needs of materials control are given as follow;
i.
To ensure the availability of materials
ii.
To ensure optimum investment in materials
iii.
To ensure minimum wastage
iv.
To provide information about the availability of materials
v.
TO ensure the reasonable price of material
The objective of
materials control
Materials control aims
at efficient purchase, storage, and consumption of materials. The following are
the objectives of material control;
o To purchase materials
at a reasonable price.
o To maintain the cost
of materials at the minimum level.
o To protect materials
against loss by fire, theft, and leakage.
o To minimize the
handling cost and time in storing and using the materials.
o To provide information
to management about raw materials, their cost, and availability.
o To avoid obsolescence
of materials by adopting an appropriate method of material issue.
o To ensure a better
quality of materials at the right quantity and at right time for efficient
Essentials of
Materials Control
The main essentials of
materials control are as follows;
o There should be up to
date record of materials
o There should be
centralized purchasing
o There should be proper
coordination between sales, production, purchase, receiving, inspection, and
storage departments.
o All items in stores
should be codified, classified, and standardized.
o The issue of materials
should be on the basis of the requisition.
STORE ROUTING
The process set by a
manufacturing company to control materials is called store routing. It consists
of all the processes involved in proper purchasing, storing, and issuing of
materials to the concerned departments. Store routing can be summarized as
follows:
1. Purchasing and
receiving of materials
o Request for purchase
of materials
o Inquiry and tender quotation
forms issued to potential suppliers
o Selecting a suitable
supplier
o Placing the order
2.Storing of materials
o Classification and
codification of materials
o Keeping records of the
materials in Bin Cards, Store ledger, and so on.
3.Issuig of materials
o Requisition form
o Pricing of materials
issued
Purchasing
Purchasing involves
acquiring materials of the right quality, at the right quantity, at right time
from the right source, and a reasonable price. A separate purchase department
should be established to perform purchasing activities. The department which
performs purchasing activities in the manufacturing concern in the managed way
is termed as the purchasing department. The purchasing department plays a very
important role in an organization because purchasing has its effect on every
vital factor concerning the manufacture, quality, cost efficiency, and prompt
delivery of goods to customers.
Purchase control
A manufacturing
company is required to invest a huge amount of money in purchasing materials.
It is, therefore, essential to exercise proper materials and purchase control.
Purchase control refers to the purchase of materials of the right quality in the
right quantity at a reasonable price and at a right time. It requires a good
amount of attention to the purchasing procedures of materials relating to cost,
quality, volume, time, and delivery of materials.
Centralized purchasing
Centralized purchasing
refers to the purchase of materials by a single purchase department. This
department is headed and managed by a purchasing manager. Under centralized
purchasing, all purchase s are made by the purchasing department to avoid
duplication, overlapping, and non-uniform procurements. Under this system, the
purchasing department purchases the required materials for all the departments
and branches of the company.
Advantages
It uses specialized
knowledge and skill by appointing specialized and expert purchasing staff.
1. It brings about the economics
of bulk purchases.
2. It facilitates the
standardization of materials.
3. It facilitates
effective control over purchases, by maintaining an efficient system of ordering,
receiving inspection, accounting, etc.
4. It ensures consistent
policy concerning purchase such as terms of payment, cost of delivery, etc.
5. It brings about the economics
of centralized accounting of purchase.
a) When there is only
one plant or
b) Several plants are
not located far away from each other and are using the same materials.
Disadvantages
1. It is expensive due to
the increase in administration cost of a separate purchase department.
2. It is not suitable
when plants of departments are located far away from one another or are using
different materials.
Decentralized
purchasing
Decentralized
purchasing refers to purchasing materials by all departments and branches
independently to fulfill their needs. Such purchasing occurs when departments
and branches purchase separately and individually. Under decentralized purchasing,
no one purchasing manager has the right to purchase materials for all
departments and divisions. The defects of centralized purchasing can be
overcome by the decentralized purchasing system. It helps to purchase the
materials immediately in case of an urgent situation.
Advantages:
1. It avoids the unnecessary
cost of setting up a purchasing department.
2. It avoids delay in
purchasing because the required material can be easily purchased as and when
required.
3. Department can get the
benefit of localized purchasing.
4. Due to the provision
of the purchase of material by the concerned department the material may be
purchased in the right quantity and quality.
Disadvantages:
1. There is a chance of
overstocking and blocks the capital of the company.
2. The benefits of a bulk
purchase cannot be obtained.
3. Fewer chances of effective
control of materials.
4. Lack of proper
cooperation and coordination among various departments.
5. There may be a lack of
special knowledge about purchasing with purchasing staff.
MATERIAL PURCHASING
AND RECEIVING PROCEDURES
Purchasing of
materials involves a number of steps which may be different from one company to
another. Generally, the following steps are involved in purchasing and
receiving materials:
1. Purchasing
requisition
Purchasing requisition
is a form used to make a formal request to the purchasing department to
purchase the materials specified there in. The purchase requisition is received
from the storekeeper for all items in regular use, production department for
specific items not regularly used and stored, production regular use, production
department development, plant engineer for material required for special
maintenance, and departmental heads for any materials required for their
department. The purpose of purchase requisition to authorized the purchasing of
the materials specified therein and provides a written record of details of the
material required.
Purchase requisition
has three purposes:
1. To inform the purchasing
department of the need or purchase materials.
2. To fix the
responsibility of the department making the purchase requisition.
3. To use for further
reference.
2. Request for quotations
or tenders
After receiving a
purchase requisition, the next step of the purchase procedure is to find the
convenient and economical sources of supply. The purchase department must
maintain a list of suppliers. The selection of a particular supplier is usually
made after inviting tenders or quotations from possible sources of supply.
Invitations for tender in a prescribed format are sent to prospective
suppliers. It contains detailed information about the availability of goods, price
of materials, and terms and conditions of purchasing.
3. Purchase order
After completion of
the above procedure, the purchasing department prepares a purchase order for
the supply of materials. The purchase order is a contractual agreement with the
suppliers for the supply of materials. It is prepared in five copies, the
original copy is sent to the supplier, the second copy for the receiving
department, third for the accounting department, fourth for the imitating department,
and the fifth one is retained in the purchasing department for reference.
4. Receiving and
inspecting materials
The receiving
department should perform the unction of unloading and receive material
dispatched by the suppliers. The receiving department verifies the materials
with the help if the delivery note and the copy of the purchase order after
receiving the delivery of goods. The suppliers send detailed information and an
invoice for the materials supplied by it. It has to verify and check the
quantity and physical condition of materials by making a comparison of the
purchase order and the materials received in large companies, an inspector is
appointed to inspect all the materials received and to prepare an inspection
report.
5. Checking and
passing of bills for payment
When the invoices are
received from the supplier, they are sent to the stores and accounting departments
for the verification of the quantity and price of materials mentioned in the
invoices. After checking the required documents, the store department requests
the accounting department for making the payment of the invoice to the
suppliers.
Store-keeping
Store keeping refers
to the act of storing materials for their safe custody until these are issued
to the production and other departments. It involves receiving, storing, and
issuing materials. The place where materials are kept is known as 'store'. The
term 'stores' has a wide meaning and includes raw materials used in production,
consumable stores such as oil, grease, etc, tools, patterns, maintenance materials,
etc, stock of work in progress, and stock of finished goods.
Objectives of
storekeeping
o All of the proper
place for every item of store
o Keep every item of the
store in a fixed place
o Maintain proper and up
to date records
o Issuing materials
quickly to department
o Classify and codify
the materials for easy identification
Types of stores
1. Centralized
stores
A centralized store is
that store that receives materials for and issues them to all department
divisions and production floors of the company. Such a store is the only one in
the company which receives materials for and issues them to all who need them.
The materials required for all the departments and branches are stored and
issued by only one store.
Advantages:
o Economy in cost
o Better supervision of
store
o Better layout and
control of stores
o The minimum investment
in store
o Less space is occupied
o Better safety and
security of stock
Disadvantages:
o Delay in sending
materials to the department and branch.
o increase in the
material handling cost.
o Greater risk of loss
by fire.
o Not suitable for a
large company.
2.Decentralized
Stores
Decentralized stores are
that type of store which receives materials for and issue them to only one
department and not to the whole company. The decentralized store may be many in
the company, as each department has its own such store. Purchasing and handling
of materials are undertaken by each and every department separately. Each and
every branch has its own store for the operation of production activities.
Advantages:
o Saving in material
handling cost
o Prompt issue of
material is possible
o Storing and control
will be easy and effective
o Smooth production will
be possible
o Risk of loss by fire
can be minimized
Disadvantages:
o Higher cost of
supervision.
o More space is required
for individual departments.
o Higher amount of
investment is required.
o More time for stock-taking
and checking.
o Higher cost for staff
and stationery.
o Improved technique is
less possible for controlling of materials.
3.Centralized stores
with sub-stores
This is a mixed store
system, a mix of centralized and decentralized stores, under this store system,
sub-stores are established in different departments according to the
requirement of the company. Sub-store is maintained at each department when the
central store is at a distance from the production department. Such sub-stores
are managed and controlled by the central store itself. At the beginning of a
period, the central store issues a fixed quantity of materials to the
sub-stores. At the end of the period, sub-stores send a filled requisition form
to the central store to maintain the stock to a pre-determined level.
Advantages:
o Overcoming the demerits
of centralized store
o Offering an easier
location for storing of materials.
o Avoiding delay in
issuing materials.
o Providing services to
meet the special needs of individual departments.
o Reducing internal
transportation cost.
Disadvantages:
o High cost for
stationery and staffing.
o High material handling
cost.
o More time in stock
talk.
o Extra set-up stock
taking.
o Complicated store
control.
LOCATION OF STORES
It refers to the place
where stores are situated. The location of stores should be near to the receiving
department so that the materials handling charges are at a minimum. There
should be an easy excess to all other departments so that the minimum of
expenses is incurred in unloading. The stores should be located considering the
nature of materials; the bulky materials should be stored nearer to the user's
department to minimize the labor and transport, the planned location charges.
In conclusion, the planned location of the store will avoid delays in the
movement of materials to the department in which these needed.
Storekeeper
A manufacturing
company appoints a person for careful storing and safeguarding materials in a
store who is called storekeeper. A storekeeper is a person who is the chief of
the stores and who is given the responsibility of store management. He is
responsible for safeguarding the materials and supplies in proper place until
they are required for production activities. A storekeeper should be
well-experienced, well-trained, honest, and familiar with the tricks of
storekeeping.
The main functions of
storekeeper are as follows;
o To maintain a proper
record of materials relating to the receipt and issue of materials.
Checking the physical quantity of materials and verify with a bin card.
o To prevent
unauthorized entrance into the storeroom.
o To maintain the stock
registers, entering therein all receipts, issues, and balances of materials.
o To check and control
losses due to evaporation, leakage, theft, and so on.
o To arrange for
physical verification of store items periodically.
o To keep the stores
always neat clean and tidy.
o To supply information
on materials, stock position, and so on whenever needed.
CLASSIFICATION AND
CODIFICATION OF MATERIALS
The process of a grouping
of materials based on their nature or usage is known as classification. The
process of giving district names and symbols for each item is called
codification. A good system of storekeeping requires an appropriate
classification codification. Materials are classified either based on their
nature or based on their consumption. Based on nature is most commonly used
such as materials are classified as construction materials, consumable stores,
spare parts, lubricating oils, etc. After the classification of materials,
these are codified alphabetically or numerically each item of the store by
giving it a separate store code number are used to indicate the main group and
the decimals to indicate primary, secondary and other groups. The main code
consists of the first two digits, sub-code consists of the next two or three digits
upon the requirement, and the last one or two digits indicate to details of the
size, quality, etc upon the requirements.
Advantages :
o Quick and easy
identification of materials.
o Helps ensure proper
material control.
o Secrecy of materials.
o Saving time in
materials handling.
o Essential for a mechanized
accounting system.
RECORDING OF MATERIALS
RECEIVED
The following are the important
store recording methods that are used for keeping records of the various items
to store:
1.BIN CARD
A document used in the
stores department to show receipt, issue, and balance of each item of materials
is called a bin card. In the bin card, the stock level like minimum stock
level, maximum stock level, reorders level of each item are mentioned. All the
receipts and issues entries made in bin card can be supported by relevant
documents such as good received a note, materials return note, stores requisition
note, etc. An entry is made at the time of each receipt or issue and the
balance in hand of the stock is calculated. The bin card shows the quantity of
materials but not the value of materials.
2.Two-bin system
In some manufacturing
companies, a bin is divided into two parts: a smaller and a larger one. The
smaller bin stores the quantity equal to the minimum quantity and the larger
part stores the remaining quantity. The quantity in the smaller part is not
issued so long as the quantity is available in the large part. A new supply is
ordered as soon as the larger bin is empty.
3.Store Ledger
A store ledger is a
record of stock, both in quantity and value, and is maintained by the store
accounting section. It consists of the same columns of a bin card, but in
addition, there is an amount column in which the value is entered. Thus, this
ledger provides information for the pricing of materials issued and the value
of materials at any time of each item of stores.
DIFFERENCE BETWEEN BIN
CARD AND STORES LEDGERS
Bin cards |
Stores
ledgers |
|
It
is maintained by the storekeeper. |
It
is prepared by cost accounting department. |
|
It is a record of quantity only. |
It is record of quantities and
values. |
|
Entries
are made immediately after each transaction. |
Entries
are made periodically. |
|
Posting are made before a
transaction. |
Posting are made after a
transaction |
|
It
is kept inside the store. |
It
is kept outside the store. |
PERPETUAL INVENTORY
SYSTEM
It is also known as an
Automatic inventory system. The perpetual inventory system is a technique of
controlling stock items by maintaining store records in a manner such that
stock balances at any point of time are readily available. The terms
"Perpetual Inventory" refer to the system of record-keeping and a
continued physical verification of the stocks, with reference to store-records.
According to Wheldon, a
perpetual inventory system is a method of recording store balance after every receipt
and issue to facilitate regular checking and to obviate closing down for
stock-taking.
The two main functions
are:
Recording store receipts
and issues to determine the stock in hand at any time, in quantity or value or
both without the need for physical counting of the stock.
Continuous verification
of the physical stock with reference to the balance recorded in the store
record is convenient for the management.
Advantages:
o It helps in rapid
stocktaking which, in turn, helps in the preparation of interim accounts.
o Morale check on the
store staff to maintain proper stock records.
o The investment in
materials and supplies may be kept at the lowest point.
o It is not necessary to
stop production so as to carry out a complete physical stocktaking.
o Deterioration,
obsolescence, etc, can be avoided.
o Discrepancies and
error can be quickly discovered and remedial action can be taken.
ISSUE OF MATERIALS
Preparation and
treatment of requisition form
The storekeeper
receives materials and other items, stores them carefully, and finally issues
them for the purpose of production. But, the storekeeper must not issue
materials unless a properly authorized materials requisition is presented to
him. Request for the issue of materials should be made to the storekeeper in
the prescribed form signed by the person demanding them. The document, which
authorizes and records the issues of materials, is known as material requisition
from.
Method of pricing
material issued
There are various
methods, in use, of pricing issues of materials form store. The selection of a
suitable method is significant from the viewpoint of cost absorbed and
consequently on profit.
Materials are purchased
specifically for a job. The material issued is charged to the job at its landed
cost. Landed cost includes the invoice price, freight, cartage, insurance, and
control charges on materials. The issue of such items cannot be linked with a
particular 'lot' and therefore, the exact landed cost of the particular unit
issued cannot be identified.
Some important methods
of pricing are as follows:
First-In-First-Out
(FIFO) Method
The method in which materials
are issued from the store on a first come first serve basis is called FIFO.
Under this method, the materials received first in stores are issued first.
Materials are issued strictly in chronological order. The first issue is made
out of the unit of opening stock, the next issue from the first purchase, and
the closing stock remained in stock always from the latest purchase.
Advantages:
o This method is easy to
understand and operate.
o It is used where
transactions are not voluminous and the prices of the materials are falling.
o This method is suitable
for bulky materials with high unit prices.
o Deterioration and
obsolescence can be avoided.
o Value of the closing
stock of materials will reflect the current market price.
Disadvantages:
o It is improper if many
lots are purchased during the period at different prices.
o The objectives of
matching current costs with current revenue cannot be achieved under this method.
o If the prices of
materials are rising rapidly, the current production costs may be understood.
o This method overstates
profit, especially in inflation.
Last-In-First-Out
(LIFO) Method
This method follows
the principle that the last items of materials purchased are issued at first.
The valuation of the materials issued is made according to the latest purchase
price of materials. The closing stocks of the materials are valued always at
the earliest prices of the materials. In the case of a rising price, this
method is suitable because the material is issued at current market prices.
Advantages
o This method is
appropriate for matching costs and revenue.
o This method is simple
to operate and easy to understand.
o It facilitates the complete
recovery of material costs.
o It is most suitable
when prices are rising.
Disadvantages
o Inventory valuation
does not reflect the current prices and therefore is useless in the context of
current conditions.
o Due to the variation in
prices, a comparison of the cost of a similar job is not possible.
o Calculations become
complicated and cumbersome when rates of receipts are highly fluctuating.
o It involves
considerable clerical work.
Simple Average Method
Under this method,
issue prices of materials are fixed at the average unit price. According
to CIMA, London. A price that is calculated by dividing the total
prices of the materials in the stock from which the material to be priced could
be drawn by the number of the prices used in that total.
The simple average is
an average of prices without considering the quantities involved.
Advantage
o It is very suitable
when materials are received in a uniform lot of quantities.
o This method is very
easy to operate,
o It reduces clerical
work.
Disadvantage
o If the quantity in
each lot varies widely, the average price will lead to erroneous costs.
o Costs are not fully
recovered.
o Closing stock is not
valued at the current cost.
Materials returned to
the store
Defective and unused
materials are returned to the store. When the materials are returned, they
should be treated as receipts and are recorded in the store ledger like the purchase
of materials. After receiving the returned materials, the storekeeper prepares
a Material Return Note, which records the return of unused
materials.
Materials returned in
the original condition may be based under one of the following methods:
a) At the same price at which they were issued
b) At the current price of an issue
According to the first
method, the returned materials are set apart and at the time of the next issue,
they are priced at the original price rate. This method treats the return as a
new purchase but values it at the original price. Under the second method, the
return is priced at the rate at which any material requisition placed on the
date would have been priced.
Stock level
Inventory refers to the
stock maintained by the manufacturing concern and trading organization to meet
their future requirement for smooth production and sales. It refers to the
different levels of stocks, which are required for efficient and effective
control of materials and balanced over and understocking of materials. The
purpose of materials control is to maintain the stock of raw materials as low
as possible and at the same time, they may be made available as and when required.
In a scientific system
of inventory control, the following levels of materials are fixed.
1. Re-order level
2. Minimum level (Safety
stock)
3. Maximum level
4. Average stock level
5. Re-order quantity
Re-order level
It is that level of
inventory which the storekeeper should initiate the purchase procedure for fresh
supplies of inventory. Re-order point is the quantity or level of the inventory
on hand that triggers a new purchase order. It is the level at which the storekeeper
initiates purchase requisition purchase for fresh supplies of material. Fresh
order should be placed before the actual stock reaches the minimum level to
continue the business activities properly.
It is calculated by,
Re-order level=
Minimum level (Safety stock) + (Average lead time
X average consumption)
Or,
Re-order level=Maximum
consumption X Maximum re-ordering period
Minimum Level or
Safety Stock
It is the level stock
where new order should be placed considering daily usage rate and lead-time.
When the volume or quantity of materials in production fall in below minimum
stock level; it shows potential leading to stock out position. Stock falls
below minimum level if consumption is more than normal consumption or re-order
period is more than normal re-order period or both of these conditions
appeared. Minimum stock level is considered as buffer stock for use during an emergency.
The following is the
formula of it,
Minimum stock level =
Re-order level - (Normal consumption X Normal lead time)
Maximum stock level
The level of stock which
is generally not allowed to be exceeded is said maximum stock level. It
represents the maximum quantity of an item of material which can be held in
stock at any time. The quantity is fixed so that their may be no over stocking
It is calculated by,
Maximum stock level =
Re-order level +Re-order quantity- (Min. consumption X Min. lead time)
Re-order quantity
First of all company
determines the quantity or size to be ordered at a time. Thereafter, it places
the order for purchasing materials by the same size or quantity, which is known
as re-order quantity. In other words, the quantity of single purchase order
while purchasing any materials is called re-order quantity.
It is calculated by,
Re-order quantity=
(Max stock level - ROL) + (Min. consumption X Min. period)
Average stock level
Average stock level
denotes the normal/moderate/average stock maintained by the firm. This level,
which indicated the average stock to be held by the firm is known as average
stock level. It is ascertained by using the following formula:
Average stock level
=(Max stock level + Mini stock level)/2
Average stock level =
mini stock level + (1/2 + re-order quantity)
Economic Order
Quantity (EOQ)
Economic order
quantity is also known as re-order quantity. It is that level of inventory
where the total cost of holding inventory is at a minimum. It is the level of
quantity at which the cost of ordering will be equal with the storage cost of
materials. In other words, the quantity of materials, which is economical to be
ordered at one time, is known as economic order quantity. The total cost of
materials consists of the ordering cost and carrying cost. While determining the
economic order quantity, the ordering cost and carrying cost should be
considered.
Carrying cost
This refers to the
cost of keeping items in stock for a certain period of time. Carrying cost is
concerned with the storing of materials. It suggests purchasing in small
quantities. If small quantities of materials are purchased, the storing cost
will be low. The following costs are included in the carrying cost.
o Storage cost
o Insurance of material
o Obsolescence loss due to a change in process or product
o Internet on capital blocked on materials
o Maintaining cost of material to avoid deterioration.
Ordering cost
All the cost, which is
related with placing an order and secure the supplied are called ordering cost. In others it refers to the cost related to the purchase-related activities.
The ordering cost is the repurchase cost and is repeated in nature. Purchasing
of large quantities of materials helps reduce the ordering cost. The following
costs are included in the ordering cost.
Cost of staff
appointed in the purchasing, inspection, and payment departments.
Cost of stationery purchases, telephone charge, email charge, faxes charge,
etc.
Formula of EOQ,
A= Annual requirement
O = Ordering cost
C = Carrying cost
Reviewed by Bijay Munikar
on
March 15, 2021
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