FAQs on Material Cost | Cost and Management Accounting

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  • Last Updated on 19 March, 2022

Material cost; cost and management accounting; purchase of material demurrage; inventory control; bin cards; store ledgers; just in time approach; stock verification; fifo; lifo

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FAQ 1. What is the difference between Bill of Material and Material Requisition note?

Ans.

Bill of Material

Material Requisition Note

It is the document prepared by the engineering or planning department. It is prepared by the production or other consuming department.
It is a complete schedule of component parts and raw materials required for a particular job or work order. It is a document asking Store-keeper to issue materials to the consuming department.
It often serves the purpose of a material requisition as it shows the complete schedule of materials required for a particular job i.e. it can replace material requisition. It cannot replace a bill of materials.
It can be used for the purpose of quotations. It is useful in arriving historical cost only.
It helps in keeping a quantitative control on materials drawn through material requisition. It shows the material actually drawn from stores.

FAQ 2. What is the treatment of items associated with purchase of material?
(i) Cash discount
(ii) Subsidy/Grant/Incentives
(iii) GST
(iv) Commission brokerage paid

Ans:

(i) Cash discount: Cash discount is not deducted from the purchase price. It is treated as interest and finance charges. It is to be ignored.

(ii) Subsidy/Grant/Incentive: Any subsidy/grant/incentive received from the Government or from other sources deducted from the cost of purchase.

(iii) GST: It is excluded from the cost of purchase if credit for the same is available. Unless mentioned specifically it should not form part of cost of purchase.

(iv) Commission or brokerage paid: Commission or brokerage paid is added with the cost of purchase.

FAQ 3. How are the following items treated in arriving at the value of cost of material purchased?
(i) Detention Charges/Fines
(ii) Demurrage
(iii) Cost of Returnable containers
(iv) Central Goods and Service Tax (CGST)
(v) Shortage due to abnormal reasons.

Ans: Treatment of items in arriving at the value of cost of material Purchased

S. No. Items

Treatment

1. Detention charges/Fine Detention charges/fines imposed for non-compliance of rule or law by any statutory authority. It is an abnormal cost and not included with cost of Purchase
2. Demurrage Demurrage is a penalty imposed by the transporter for delay in uploading or offloading of materials. It is an abnormal cost and not included with cost of purchase.
3. Cost of returnable containers If the containers are returned and their costs are refunded, then cost of containers should not be considered in the cost of purchase.

If the amount of refund on returning the container is less than the amount paid, then, only the short fall is added with the cost of purchase.

4. Central Goods and Service Tax (CGST) Central Goods and Service Tax (CGST) is paid on manufacture and supply of goods and collected from the buyer. It is excluded from the cost of purchase if the input credit is available for the same. Unless mentioned specifically CGST is not added with the cost of purchase.
5. Shortage due to abnormal reasons Shortage arises due to abnormal reasons such as material mishandling, pilferage, or due to any avoidable reasons are not absorbed by the good units. Losses due to abnormal reasons are debited to costing profit and loss account.

FAQ 4. What is the difference between Bin Cards and Stores Ledgers.

Ans:

Bin cards

Stores Ledger

Bin Cards is maintained by the store keeper in the store. Store ledger is maintained in cost accounting department.
It contains only quantitative details of material received, issued and returned to stores. It contains information both in quantity and value.
Entries are made when transaction takes place. It is always posted after the transaction.
Each transaction is individually posted. Transactions may be summarized and then posted.
Inter-department transfers do not appear in Bin Card. Material transfers from one job to another job are recorded for costing purposes.

FAQ 5. What is Inventory control and what are the basis to be adopted for inventory control?

Ans: The Chartered Institute of Management Accounts (CIMA) defines Inventory Control as “The function of ensuring that sufficient goods are retained in stock to meet all requirements without carrying unnecessarily large stocks”.

The objective of inventory control is to make a balance between sufficient stock and over-stock. The stock maintained should be sufficient to meet the production requirements so that uninterrupted production flow can be maintained. Insufficient stock not only pause the production but also cause a loss of revenue and goodwill.

On the other hand, Inventory requires some funds for purchase, storage, maintenance of material with a risk of obsolescence, pilferage etc. A trade-off between stock-out and over-stocking is required. The management may employ various methods of inventory a balance.

Management may adopt the following basis for Inventory Control:

    • By Setting Quantitative Levels
    • On the basis of Relative Classification
    • Using Ratio Analysis
    • Physical control

FAQ 6. What is ‘Just In Time’ (JIT) approach of inventory management?

Ans: JIT is a system of inventory management with an approach to have a zero inventories in stores. According to this approach material should only be purchased when it is actually required for production.

JIT is based on two principles

(i)   Produce goods only when it is required and

(ii)   The products should be delivered to customers at the time only when they want.

It is also known as ‘Demand pull’ or ‘Pull through’ system of production. In this system, production process actually starts after the order for the products is received. Based on the demand, production process starts and the requirement for raw materials is sent to the purchase department for purchase. The steps followed in this system are as follows:

Demand for final product Production starts to process the demand for product Material requirement is sent to Purchase department Order for raw materials sent to supplier Supplier sent the material for production

FAQ 7. What is ABC Analysis as a system of Inventory Control?

Ans: It is an important technique of inventory control on selective basis whereby the measure of control over an item of inventory varies with its usage value. It exercises discriminatory control over different items of stores grouped on the basis of the investment involved. Usually the items of material are grouped into three categories viz; A, B and C according to their use value during a period:

(i) ‘A’ Category of items consists of only a small percentage i.e., about 10% of the total items of material handled by the stores but 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 items of material handled by stores. The percentage of investment required is about 20% of the total investment in inventories.

(iii) ‘C’ category of items does not require much investment. It may be about 10% of total inventory value but they are nearly 70% of the total items handled by stores.

FAQ 8. How are slow-moving and non-moving items of stores detected and what steps are necessary to reduce such stocks?

Ans:

Slow-moving and non-moving items of stores can be detected in the following ways:

1. By preparing & scanning periodic reports showing the status of different items of stores.
2. By calculating the stock holding of various items in terms of numbers of days/months of consumption as a percentage.
3. By computing ratios periodically, relating to the issues of average stock held
4. By implementing the use of a well designed information system.

Steps to reduce stock of slow moving and non-moving items of stores:

1. Proper procedures and guidelines should be laid down for the disposal of non-moving items, before they further deteriorates in value.
2. Diversity in production to use up such materials.
3. Use these materials as substitute in place of other materials.

FAQ 9. What is perpetual inventory records and continuous stock verification?

Ans:

Perpetual Inventory Records: Perpetual inventory represents a system of records maintained by the stores department. It comprises of: (i) Bin Cards, and (ii) Stores Ledger.

The success of perpetual inventory depends upon the following:

(a) The Stores Ledger showing quantities and amount of each item.
(b) Stock Control cards (or Bin Cards).
(c) Reconciling the quantity balances shown by stores ledger and bin cards.
(d) Checking the physical balances of a number of items every day systematically and by rotation.
(e) Explaining promptly the causes of discrepancies, if any, between physical balances and the book figures.
(f) Making corrective entries wherever required and
(g) Removing the causes of the discrepancies.

Continuous Stock Verification:

The checking of physical inventory is an essential feature of every sound system of material control. The system of continuous stock-taking consists of physical verification of items of inventory. The stock verification may be done by internal audit department but are independent of the store and production staff. Stock verification is done at appropriate interval of time without prior notice. The element of surprise is essential for effective control of the system.

FAQ 10. What are the advantages of perpetual inventory records and continuous stock verification?

Ans:

Advantages of Perpetual Inventory Records:

1. Physical stocks can be counted and book balances can be adjusted as and when desired without waiting for the entire stock-taking to be done.
2. Quick compilation of Profit and Loss Account for interim period due to prompt availability of stock figures.
3. Discrepancies are easily located and thus corrective action can be promptly taken.
4. It reveals the existence of surplus, dormant, obsolete and slow-moving materials, so that remedial measures may be taken in time.
5. Fixation of the various stock levels and checking of actual balances in hand with these levels assist the store keeper in maintaining stocks within limits and in initiating purchase requisitions for correct quantity at the appropriate time.

Advantages of Continuous Stock Taking:

1. Closure of normal functioning is not necessary.
2. Stock discrepancies are likely to be brought to the notice and corrected much earlier than under the annual stock-taking system.
3. The system generally has a sobering influence on the stores staff because of the element of surprise present therein.
4. The movement of stores items can be watched more closely by the stores auditor so that chances of obsolescence buying are reduced.
5. Final Accounts can be ready quickly. Interim accounts are possible quite conveniently.

FAQ 11. Perpetual inventory system comprises Bin Card and Stores Ledger, but the efficacy of the system depends on continuous stock taking.

Ans: Perpetual Inventory system represents a system of records maintained by the stores department. Records comprise of

(i) Bin Cards and

(ii) Stores Ledger.

Bin Card maintains a quantitative record of receipts, issues and closing balances of each item of stores. Like a bin card, the Stores Ledger is maintained to record all receipt and issue transactions in respect of materials. It is filled up with the help of goods received note and material requisitions. But a perpetual inventory system’s efficacy depends on the system of continuous stock taking.

Continuous stock taking means the physical checking of the records i.e. Bin cards and store ledger with actual physical stock. Perpetual inventory is essentially necessary for material control. It incidentally helps continuous stock taking.

The main advantages of continuous stock taking are as follows:

1. Closure of normal functioning is not necessary.
2. Stock discrepancies are likely to be brought to the notice and corrected much earlier than under the annual stock-taking system.
3. The system generally has a sobering influence on the stores staff because of the element of surprise present therein.
4. The movement of stores items can be watched more closely by the stores auditor so that chances of obsolescence buying are reduced.
5. Final Accounts can be ready quickly. Interim accounts are possible quite conveniently.

FAQ 12. What is FIFO and LIFO method of stores issue?

Ans:

First-in First-out (FIFO) method: It is a method of pricing the issues of materials, in the order in which they are purchased. In other words, the materials are issued in the order in which they arrive in the store or the items longest in stock are issued first. Thus each issue of material only recovers the purchase price which does not reflect the current market price.

It is suitable in times of falling price since the material cost charged to production will be high while the replacement cost of materials will be low. But, in case of rising prices, if this method is adopted, the charge to production will be high while the replacement cost of material will be low.

Consequently, it would be difficult to purchase the same volume of materials (as in the current period) in future without having additional capital resources.

Last-in-First-out (LIFO) method: It is a method of pricing the issues of materials on the basis of assumption that the items of the last batch (lot) purchased are the first to be issued. Therefore, under this method, the prices of the last batch (lot) are used for pricing the issues, until it is exhausted. Where the quantity of issue is more than the quantity of the latest lot, then earlier lot and its price will also be taken into consideration.
During inflationary period or period of rising prices, the use of LIFO would help to ensure that the cost of production determined on the above basis is approximately the current one.

FAQ 13. Why does the Last in First out (LIFO) has an edge over First in First out (FIFO) or any other method of pricing material issues?

Ans:
LIFO has following advantages:

(a) The cost of the material issued will be reflecting the current market price.
(b) The use of the method during the period of rising prices does not reflect undue high profit in the income statement.
(c) In the case of falling price, profit tend to rise due to lower material cost, yet the finished goods appear to be more competitive and are at market price.
(d) During the period of inflation, LIFO will tend to show the correct profit.

FAQ 14. What is the accounting treatment of spoilage, defectives and scrap in Cost Accounting?

Ans:

Treatment of Spoilage in Cost Accounting:

Spoilage is the term used for materials which are badly damaged in manufacturing operations, and they cannot be rectified economically and hence taken out of the process to be disposed of without further processing.

    • Normal Spoilage: Normal spoilage (i.e., which is inherent in the operation) costs are included in costs, either by charging it to the production order or to the production overhead so that it is spread over all the products. Any value realised from spoilage is credited to production order or production overhead account, as the case may be.
    • Abnormal Spoilage: Abnormal Spoilage (i.e., arising out of causes not inherent in manufacturing process) costs are charged to Costing Profit and Loss Account. When spoiled work is the result of rigid specification, the cost of spoiled work is absorbed by good production while the cost of disposal is charged to production overhead.

Treatment of Defectives in Cost Accounting:

Defectives are those units or portions of production which do not meet the quality standards due to sub-standard materials, bad-supervision, bad-planning, poor workmanship, inadequate-equipment and careless inspection.

    • Normal Defects: An amount equal to the cost less realisable value on sale of defectives is charged to material cost of good production.
    • Abnormal Defects: Material Cost of abnormal defectives are not included in material cost but treated as loss after giving credit to the realisable value of such defectives and is transferred to costing profit and loss account.

Treatment of Scrap in Cost Accounting:

Scraps are the materials which are discarded and disposed-of without further treatment. Generally, scrap has either no value or insignificant value. Sometimes, it may be reintroduced into the process as raw material.

    • Normal Scrap: The cost of scrap is borne by good units and income arises on account of realisable value is deducted from the cost.
    • Abnormal Scrap: The scrap account should be charged with full cost and the credit is given to the job or process concerned. The profit or loss in the scrap account due to realization will be transferred to the Costing Profit and Loss Account.

FAQ 15. What is obsolescence and circumstances under which materials become obsolete? What are the steps to be taken for its treatment?

Ans: Obsolescence is the loss in the intrinsic value of an asset due to its supersession. In other words, it refers to the loss in the value of an asset due to technological advancements.

Materials may become obsolete under any of the following circumstances:

    • when it is a spare part or component of a machinery used in manufacture and that machinery become obsolete,
    • where it is used in the manufacture of a product which has now become obsolete,
    • where the material itself is replaced by another material due to either improved quality or fall in price.

Treatment: In all three cases, the value of the obsolete material held in a stock is a total loss and immediate steps should be taken to dispose it off at the best available price. The loss arising out of obsolete materials is an abnormal loss and it does not form part of the cost of manufacture.

FAQ 16. What are the differences between ‘scrap’ and ‘defectives’ and how they are treated in cost accounting?

Ans.

Scrap

Defectives

It is the loss connected with the output It is the loss connected with the output as well as input.
Scraps are not intended but cannot be eliminated due to nature of material or process itself. Defectives also are not intended but can be eliminated through proper control system.
Generally scraps are not used or rectified. Defectives can be used after rectification.
Scraps have insignificant recoverable value. Defectives are sold at a lower value from that of the good one.

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