ICAI Notes: Material Cost | Cost and Management Accounting for CA Intermediate PDF Download

 Page 1


 
    
CHAPTER 
2
 
  
 
  MATERIAL COST 
 
After studying this chapter, you would be able to- 
? State the meaning, need and importance of materials. 
? Discuss the procedures and documentations involved in 
procuring, storing and issuing material. 
? Discuss the various inventory control techniques and 
determination of various stock levels. 
? Compute Economic Order Quantity (EOQ) and apply the 
EOQ to determine the optimum order quantity. 
? Discuss the various methods of inventory accounting and 
Prepare stock ledger/ account. 
? Identify and explain normal and abnormal loss and its 
accounting treatment. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
Page 2


 
    
CHAPTER 
2
 
  
 
  MATERIAL COST 
 
After studying this chapter, you would be able to- 
? State the meaning, need and importance of materials. 
? Discuss the procedures and documentations involved in 
procuring, storing and issuing material. 
? Discuss the various inventory control techniques and 
determination of various stock levels. 
? Compute Economic Order Quantity (EOQ) and apply the 
EOQ to determine the optimum order quantity. 
? Discuss the various methods of inventory accounting and 
Prepare stock ledger/ account. 
? Identify and explain normal and abnormal loss and its 
accounting treatment. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
 
 
 
    
2.2 
COST AND MANAGEMENT ACCOUNTING 
 
 1. INTRODUCTION 
We have acquired a basic knowledge about the concepts, objectives, advantages, 
methods and elements of cost. We shall now study each element of cost 
separately beginning with material cost. The general meaning of material is all 
commodities/ physical objects used to make the final product. It may be 
direct or indirect.  
(i) Direct Materials: Materials, cost of which can be directly attributable to the 
end product for which it is being used, in an economically feasible way. 
(ii) Indirect Materials: Those materials which are not directly attributable to a 
particular final product.  
Direct Materials constitute a significant part for manufacturing and production of 
goods. Being an input and a significant cost element, it requires adequate 
 1. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


 
    
CHAPTER 
2
 
  
 
  MATERIAL COST 
 
After studying this chapter, you would be able to- 
? State the meaning, need and importance of materials. 
? Discuss the procedures and documentations involved in 
procuring, storing and issuing material. 
? Discuss the various inventory control techniques and 
determination of various stock levels. 
? Compute Economic Order Quantity (EOQ) and apply the 
EOQ to determine the optimum order quantity. 
? Discuss the various methods of inventory accounting and 
Prepare stock ledger/ account. 
? Identify and explain normal and abnormal loss and its 
accounting treatment. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
 
 
 
    
2.2 
COST AND MANAGEMENT ACCOUNTING 
 
 1. INTRODUCTION 
We have acquired a basic knowledge about the concepts, objectives, advantages, 
methods and elements of cost. We shall now study each element of cost 
separately beginning with material cost. The general meaning of material is all 
commodities/ physical objects used to make the final product. It may be 
direct or indirect.  
(i) Direct Materials: Materials, cost of which can be directly attributable to the 
end product for which it is being used, in an economically feasible way. 
(ii) Indirect Materials: Those materials which are not directly attributable to a 
particular final product.  
Direct Materials constitute a significant part for manufacturing and production of 
goods. Being an input and a significant cost element, it requires adequate 
 1. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
2.3  
MATERIAL COST  
    
2.3 
management attention. Cost control starts from here, and for this purpose it is 
necessary that the principle of 3Es (Economy, Efficiency and Effectiveness) i.e. 
economy in procurement, efficiency in handling and processing the material and 
effectiveness in producing desired output as per the standard, is also applied for 
this cost element. Importance of proper recording and control of material are as 
follows: 
(a) Quality of final product: The quality of output depends on the quality of 
inputs.  
(b) Price of the final product: Material constitutes a significant part of any 
product and the cost of final product is directly related with cost of materials 
used to produce the product.  
(c) Production continuity: The production firms need to ensure that 
production process  runs smoothly and should not be paused for the want 
of materials. In order to  avoid production interruptions, an adequate level 
of stock of materials should be maintained.    
(d) Cost of Stock holding and stock-out: An entity has to incur stock holding 
costs in the form of interest and/or opportunity cost for the fund used, stock 
handling losses like evaporation, obsolescence etc. Under-stocking causes in 
loss of revenue due to stock-out and breach of commitment.  
(e) Wastage and other losses: While handling and processing of materials, 
some wastage and loss arise. Based on the nature of material and process, 
these are classified as normal and abnormal for efficient utilisation and 
control. 
(f) Regular information about resources: Regular and updated information 
on availability and utilisation of materials are necessary for the entity for 
timely and informed decision making. 
 2. MATERIAL CONTROL  
In the previous chapter, we have discussed the term Cost Control, which means all 
activities and control mechanism which are necessary to keep the cost in 
adherence to the set standards. Material, being one of the total cost elements, are 
also required to be controlled so that the overall cost control objective can be 
fulfilled. 
 2. 
© The Institute of Chartered Accountants of India
Page 4


 
    
CHAPTER 
2
 
  
 
  MATERIAL COST 
 
After studying this chapter, you would be able to- 
? State the meaning, need and importance of materials. 
? Discuss the procedures and documentations involved in 
procuring, storing and issuing material. 
? Discuss the various inventory control techniques and 
determination of various stock levels. 
? Compute Economic Order Quantity (EOQ) and apply the 
EOQ to determine the optimum order quantity. 
? Discuss the various methods of inventory accounting and 
Prepare stock ledger/ account. 
? Identify and explain normal and abnormal loss and its 
accounting treatment. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
 
 
 
    
2.2 
COST AND MANAGEMENT ACCOUNTING 
 
 1. INTRODUCTION 
We have acquired a basic knowledge about the concepts, objectives, advantages, 
methods and elements of cost. We shall now study each element of cost 
separately beginning with material cost. The general meaning of material is all 
commodities/ physical objects used to make the final product. It may be 
direct or indirect.  
(i) Direct Materials: Materials, cost of which can be directly attributable to the 
end product for which it is being used, in an economically feasible way. 
(ii) Indirect Materials: Those materials which are not directly attributable to a 
particular final product.  
Direct Materials constitute a significant part for manufacturing and production of 
goods. Being an input and a significant cost element, it requires adequate 
 1. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
2.3  
MATERIAL COST  
    
2.3 
management attention. Cost control starts from here, and for this purpose it is 
necessary that the principle of 3Es (Economy, Efficiency and Effectiveness) i.e. 
economy in procurement, efficiency in handling and processing the material and 
effectiveness in producing desired output as per the standard, is also applied for 
this cost element. Importance of proper recording and control of material are as 
follows: 
(a) Quality of final product: The quality of output depends on the quality of 
inputs.  
(b) Price of the final product: Material constitutes a significant part of any 
product and the cost of final product is directly related with cost of materials 
used to produce the product.  
(c) Production continuity: The production firms need to ensure that 
production process  runs smoothly and should not be paused for the want 
of materials. In order to  avoid production interruptions, an adequate level 
of stock of materials should be maintained.    
(d) Cost of Stock holding and stock-out: An entity has to incur stock holding 
costs in the form of interest and/or opportunity cost for the fund used, stock 
handling losses like evaporation, obsolescence etc. Under-stocking causes in 
loss of revenue due to stock-out and breach of commitment.  
(e) Wastage and other losses: While handling and processing of materials, 
some wastage and loss arise. Based on the nature of material and process, 
these are classified as normal and abnormal for efficient utilisation and 
control. 
(f) Regular information about resources: Regular and updated information 
on availability and utilisation of materials are necessary for the entity for 
timely and informed decision making. 
 2. MATERIAL CONTROL  
In the previous chapter, we have discussed the term Cost Control, which means all 
activities and control mechanism which are necessary to keep the cost in 
adherence to the set standards. Material, being one of the total cost elements, are 
also required to be controlled so that the overall cost control objective can be 
fulfilled. 
 2. 
© The Institute of Chartered Accountants of India
 
 
 
    
2.4 
COST AND MANAGEMENT ACCOUNTING 
2.1 Objectives of System of Material Control 
The objectives of a system of material control are as following: 
(i) Minimising interruption in production process: Material Control system 
ensures that no activity, particularly production, suffers from interruption for 
want of materials and stores. It should be noted that this requires constant 
availability of every item that may be needed in production process, 
howsoever, small its cost may be.  
(ii) Optimisation of Material Cost: The overall material costs includes price, 
ordering costs and holding costs. Since all the materials and stores are 
acquired at the lowest possible price considering the required quality and 
other relevant factors like reliability in respect of delivery, etc., holding cost 
too needs to be minimized. 
(iii) Reduction in Wastages: Material Control System has an objective of 
avoidance of unnecessary losses and wastages that may arise from 
deterioration in quality due to defective or long storage or from 
obsolescence. It may be noted that losses and wastages in the process of 
manufacture are a  concern of the production department. 
(iv) Adequate Information: The system of material control maintains proper 
records to ensure that reliable information is available for all items of materials 
and stores. This not only helps in detecting losses and pilferages but also 
facilitates proper production planning. 
(v) Completion of order in time: Proper material management is very 
necessary for fulfilling orders of the firm. This adds to the goodwill of the 
firm. 
2.2 Requirements of Material Control 
Material control requirements can be summarised as follows: 
1. Proper co-ordination of all departments involved viz., finance, purchasing, 
receiving, inspection, storage, accounting and payment. 
2. Determining purchase procedure to see that purchases are made, after 
making suitable enquiries, at the most favourable terms to the firm. 
© The Institute of Chartered Accountants of India
Page 5


 
    
CHAPTER 
2
 
  
 
  MATERIAL COST 
 
After studying this chapter, you would be able to- 
? State the meaning, need and importance of materials. 
? Discuss the procedures and documentations involved in 
procuring, storing and issuing material. 
? Discuss the various inventory control techniques and 
determination of various stock levels. 
? Compute Economic Order Quantity (EOQ) and apply the 
EOQ to determine the optimum order quantity. 
? Discuss the various methods of inventory accounting and 
Prepare stock ledger/ account. 
? Identify and explain normal and abnormal loss and its 
accounting treatment. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
 
 
 
    
2.2 
COST AND MANAGEMENT ACCOUNTING 
 
 1. INTRODUCTION 
We have acquired a basic knowledge about the concepts, objectives, advantages, 
methods and elements of cost. We shall now study each element of cost 
separately beginning with material cost. The general meaning of material is all 
commodities/ physical objects used to make the final product. It may be 
direct or indirect.  
(i) Direct Materials: Materials, cost of which can be directly attributable to the 
end product for which it is being used, in an economically feasible way. 
(ii) Indirect Materials: Those materials which are not directly attributable to a 
particular final product.  
Direct Materials constitute a significant part for manufacturing and production of 
goods. Being an input and a significant cost element, it requires adequate 
 1. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
2.3  
MATERIAL COST  
    
2.3 
management attention. Cost control starts from here, and for this purpose it is 
necessary that the principle of 3Es (Economy, Efficiency and Effectiveness) i.e. 
economy in procurement, efficiency in handling and processing the material and 
effectiveness in producing desired output as per the standard, is also applied for 
this cost element. Importance of proper recording and control of material are as 
follows: 
(a) Quality of final product: The quality of output depends on the quality of 
inputs.  
(b) Price of the final product: Material constitutes a significant part of any 
product and the cost of final product is directly related with cost of materials 
used to produce the product.  
(c) Production continuity: The production firms need to ensure that 
production process  runs smoothly and should not be paused for the want 
of materials. In order to  avoid production interruptions, an adequate level 
of stock of materials should be maintained.    
(d) Cost of Stock holding and stock-out: An entity has to incur stock holding 
costs in the form of interest and/or opportunity cost for the fund used, stock 
handling losses like evaporation, obsolescence etc. Under-stocking causes in 
loss of revenue due to stock-out and breach of commitment.  
(e) Wastage and other losses: While handling and processing of materials, 
some wastage and loss arise. Based on the nature of material and process, 
these are classified as normal and abnormal for efficient utilisation and 
control. 
(f) Regular information about resources: Regular and updated information 
on availability and utilisation of materials are necessary for the entity for 
timely and informed decision making. 
 2. MATERIAL CONTROL  
In the previous chapter, we have discussed the term Cost Control, which means all 
activities and control mechanism which are necessary to keep the cost in 
adherence to the set standards. Material, being one of the total cost elements, are 
also required to be controlled so that the overall cost control objective can be 
fulfilled. 
 2. 
© The Institute of Chartered Accountants of India
 
 
 
    
2.4 
COST AND MANAGEMENT ACCOUNTING 
2.1 Objectives of System of Material Control 
The objectives of a system of material control are as following: 
(i) Minimising interruption in production process: Material Control system 
ensures that no activity, particularly production, suffers from interruption for 
want of materials and stores. It should be noted that this requires constant 
availability of every item that may be needed in production process, 
howsoever, small its cost may be.  
(ii) Optimisation of Material Cost: The overall material costs includes price, 
ordering costs and holding costs. Since all the materials and stores are 
acquired at the lowest possible price considering the required quality and 
other relevant factors like reliability in respect of delivery, etc., holding cost 
too needs to be minimized. 
(iii) Reduction in Wastages: Material Control System has an objective of 
avoidance of unnecessary losses and wastages that may arise from 
deterioration in quality due to defective or long storage or from 
obsolescence. It may be noted that losses and wastages in the process of 
manufacture are a  concern of the production department. 
(iv) Adequate Information: The system of material control maintains proper 
records to ensure that reliable information is available for all items of materials 
and stores. This not only helps in detecting losses and pilferages but also 
facilitates proper production planning. 
(v) Completion of order in time: Proper material management is very 
necessary for fulfilling orders of the firm. This adds to the goodwill of the 
firm. 
2.2 Requirements of Material Control 
Material control requirements can be summarised as follows: 
1. Proper co-ordination of all departments involved viz., finance, purchasing, 
receiving, inspection, storage, accounting and payment. 
2. Determining purchase procedure to see that purchases are made, after 
making suitable enquiries, at the most favourable terms to the firm. 
© The Institute of Chartered Accountants of India
2.5  
MATERIAL COST  
    
2.5 
3. Use of standard forms for placing the order, noting receipt of goods, 
authorising issue of the materials etc. 
4. Preparation of budgets concerning materials, supplies and equipment to 
ensure economy in purchasing and use of materials. 
5. Operation of a system of internal check so that all transactions involving 
materials, supplies and equipment purchases are properly approved and 
automatically checked. 
6. Storage of all materials and supplies in a well designated location with 
proper safeguards. 
7. Operation of a system of perpetual inventory together with continuous stock 
checking so that it is possible to determine, at any time, the amount and the 
value of each kind of material in stock. 
8. Operation of a system of stores control and issue so that there will be delivery 
of materials upon requisition to departments in the right amount at the time 
they are needed. 
9. Development of system of controlling accounts and subsidiary records which 
exhibit summary and detailed material costs at the stage of material receipt 
and consumption. 
10. Regular reports of materials purchased issue from stock, inventory balances, 
obsolete stock, goods returned to vendors, and spoiled or defective units 
are required. 
2.3 Elements of Material Control 
Material control is a systematic control over the procurement, storage and usage 
of material so as to maintain an even flow of material. 
 
Material Control
Material
Procurement 
Control
Material Storage 
Control
Material Usage 
Control
© The Institute of Chartered Accountants of India