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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
CMA
Professional Level –I
102: Cost Accounting
Class
No.
3&4
102.03
Costing and
Control of Materials
-Classification of Materials; -Accounting for Materials;
-Pricing the Issue of Materials Valuation of Inventory;
-Periodic Inventory System and Perpetual Inventory System;
-Inventory Planning; -Ordering Cost, -Holding Cost and EOQ;
-Effect of Quantity Discounts on EOQ;
-Safety Stock and Reorder Point; -Material Control Methods;
-Impact of JIT on Inventory Accounting;
-Materials Requirement Planning System.
Material is anything made of matter, constituted of one or more substances. Wood, cement, hydrogen, air and
water are all examples of materials. Sometimes the term "material" is used more narrowly to refer to substances
or components with certain physical properties that are used as inputs to production or manufacturing. In this
sense, materials are the parts required to make something else, from buildings and art to stars and computers.
Material Cost - price paid for product's raw materials
the cost of the raw materials that go into a product. The material cost of a product excludes any indirect
costs, for example, overhead or wages, associated with producing the item.
Classification of Materials:
•
•
•
•
•
•
Metals
Ferrous metals and alloys (irons, carbon steels,
alloy steels, stainless steels, tool and die steels)
Nonferrous metals and alloys (aluminum, copper,
magnesium, nickel, titanium, precious metals,
refractory metals, superalloys)
Ceramics
Glasses
Glass ceramics
Graphite
Diamond
•
•
•
Polymeric
Thermoplastics plastics
Thermoset plastics
Elastomers
•
•
•
•
•
Composites
Reinforced plastics
Metal-matrix composites
Ceramic-matrix composites
Sandwich structures
Concrete
Accounting for Materials
- Purchase of materials Purchase Requisition Purchase Order Receiving Report
- Issuance of materials Materials requisition form
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Class note for
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102:COA (Cost Accounting)
Purchasing Procedure
(1) Specification of Material.
(2) Purchase Requisition.
(3) Selection of Suppliers.
(4) Purchase Orders.
(5) Goods Received Note.
(6) Inspection of Materials.
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Manufacturing vs. nonmanufacturing costs
Pricing the Issue of Materials Valuation of Inventory;
Inventory Control: An inventory control system is a process for managing and locating objects or
materials.Inventory control is concerned with minimizing the total cost of inventory.Inventory control is the
delicate balance of the costs versus profits associated with having stock on hand.
Inventory Control is the supervision of supply, storage and accessibility of items in order to ensure an
adequate supply without excessive oversupply.It can also be referred as internal control - an accounting
procedure or system designed to promote efficiency or assure the implementation of a policy or safeguard
assets or avoid fraud and error etc.
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Class note for
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102:COA (Cost Accounting)
Formula for Materials:
Normally Stock of material is valued either at cost price or Market Price whichever is lower.
Pricing of material Issues:1) Cost price method:a) Specific price method
b) First in First Out method (FIFO)
c) Last in First Out method (LIFO)
d) Base stock method
Reorder Period OR
Delivery Period OR
Lead Time :- It represent the time gap involves between placement of
order & Actual Receiving of the Delivery. Such Period is again divided into
Maximum Period, Minimum Period, Average Period & Emergency Period.
2) Average price method:a) Simple average price method =
Total unit price
Total No. of purchases
b) Weighted average price method =
Total cost
Total No. of units
c) Periodic simple average price method = Total unit price of certain period
Total Number of purchases of that period
(This rate is used for all issues for that period. Period means a month (or) week (or) year)
d) Periodic weighted average price method = Total cost of certain period
Total Number of units of that period
e) Moving simple average price method
= Total of periodic simple average of certain number of periods
Number of periods
f) Moving weighted average price method
= Total of periodic weighted average of certain number of periods
Number of periods
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102:COA (Cost Accounting)
3) Market price method:a) Replacement price metho
hod = Issues are valued as if it was purchased now at current market price
b) Realizable price method = Issues are valued at price if it is sold now
4) Notional price method:a) Standard price method = Mater
terials are priced at pre determined rate (or) Standard
rd rate
b) Inflated price method = The
e is
issue price is inflated to cover the losses incurred due
du to natural (or)
clima
atic losses
5) Re use price method = When mat
aterials are returned (or) rejected it is valued at differe
rent price.
There is no final procedure for this method.
hod like
Under the Cost Price criteria metho
-
FIFO [First In First Out],
LIFO [Last In First Out],
Weighted Average,
Simple Average are used.
The above approaches are related to calculation & valuation of material stock. Howeverr it is equally important
to control the material cost. For contro
trolling the cost, it is necessary to decide how much should
sh
be purchased,
when to purchased, what should be st
stock level, how much discount should be demanded
d from the supplier etc.
It is also necessary to keep check ove
ver material turnover. For controlling the material cost.
st.
FIFO (First In First Out): This invento
ntory valuation method means those products that arri
rrive in inventory first,
are first to be sold.
LIFO
LIFO (Last In First Out): This invento
ntory method implies that the most recent received pro
roduct into inventory is
the first to be sold.
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Class note for
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102:COA (Cost Accounting)
Advantages of LIFO Costing
Following advantages are associated with LIFO costing method:
• The rationale of charging most recent costs to the current period production and be compared to the
current period revenues results in a systematic and realistic pricing of material consumed.
• Another benefit of LIFO costing is that it minimizes the unrealized gains and losses of inventory and
industries facing fast material price fluctuations can stabilize their reported operating profits.
• As in LIFO costing current period inflationary prices of raw material are charged to cost of production
and are deducted from revenues, therefore it reduces the profit figure resulting in tax savings. This cash
saving advantage enhances the working capital of the firm.
Disadvantages of LIFO Costing
Following disadvantages are associated with LIFO costing method:
• Regulatory bodies often adopt strict measure as a check over LIFO method. In some cases LIFO
costing technique is even restricted due to reduction in tax collections to the internal revenue services.
• Record keeping requirements under LIFO are substantially higher than any other method of inventory
costing.
• Deterioration or decay of material is maximized due to early use of the latest purchases and latest use
of the oldest receipts.
• The Cost Accounting Standards Board does not recognize the use of LIFO method except in some
special cases.
• Due to accelerated rate of inflation in the last few years the adoption of LIFO costing technique gained
some appeal from industries but the decision to adopt LIFO should be taken abruptly without keeping
its long term repercussions.
Average Cost:
Average cost simply takes a weighted average of inventory costs over time and assigns this value to the
inventory. It can be seen as a value that is neither a negative nor a positive in the sense that it doesn’t
discriminate between “first-in, first-sold” or “last-in, first-sold”.
Weighted Average Method
The weighted average method is used to assign the average cost of production to a product. Weighted average
costing is commonly used in situations where:
• Inventory items are so intermingled that it is impossible to assign a specific cost to an individual unit.
• The accounting system is not sufficiently sophisticated to track FIFO or LIFO inventory layers.
• Inventory items are so commoditized (i.e., identical to each other) that there is no way to assign a cost
to an individual unit.
Calculating Weighted Average Cost:
Since the cost per unit and volume ordered fluctuates, a heavier volume might correlate to various prices. In
order for the weighted average to be truly representative, use the following calculation:
{(April Price X Volume) + (May Price X Volume) + (June Price X Volume)} / Total Volume Ordered
{($2.00 x 200) + ($2.25 x 300) + ($2.35 X 400)}/ 900
{($400) + ($675) + ($940)} / 900
$2015/900 = $2.23 Weighted Average Cost
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
An Example of LIFO vs. FIFO vs. Average Cost in Inventory Valuation
A company purchasing inventory of an item in April at $2.00, May at $2.25 and June at $2.35. In each of
these months, the company purchased 200, 300 and then 400 of these items. These purchases are
represented in the table below.
•
•
•
•
•
Total Volume Ordered: 900 Units
Total Inventory Value: $2,015.00
LIFO Assumes that the June Inventory is sold first = $2.35
FIFO Assumes that the April Inventory is sold first = $2.00
Average Cost applies a “weighted” average to inventory = $2.23
FIFO Income Statement
LIFO Income Statement Example:
Here’s an example of how FIFO looks on an Income
Statement. With this inventory method, the
company’s COGS are lower and ending inventory is
higher. This is because the earlier inventory is used
first and we’ve matched sales with this lower valued
inventory.
Here’s an example of how LIFO looks on an Income
Statement. With this inventory valuation method, the
COGS are higher and ending inventory value
lower. We have a lower inventory value because the
last inventory purchased is more expensive and we’ve
matched our sales to this higher valued inventory.
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Class note for
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102:COA (Cost Accounting)
Calculations: COGS, Gross Profit & N
Net Profit in
above table
1. COGS (Beginning Inventory + N
New
Purchases) – Ending Inventory
ry = ($6,000.00
+ $10,000.00) - $10,000 =$6,00
000.00
2. Gross Profit: Sales – “COGS” = $15,000.00 $6,000.00 = $9,000.00
3. Net Profit: Gross Profit – Expen
enses = $9,000
- $2,500.00= $6,500.00
Calculations: COGS, Gross Profit
fit and Net Profit in
above table.
1. COGS (Beginning Invento
ntory + New
Purchases) – Ending Inventory
In
= ($6,000.00 + $10,000
00.00) - $5,000
=$11,000.00
2. Gross Profit: Sales – “CO
OGS” = $15,000.00 $11,000.00 = $4,000.00
.00
3. Net Profit: Gross Profit – Expenses = $4,000
- $2,500.00= $1,500.00
00
Specific Identification Method
The specific identification method refe
fers to the tracking and costing of inventory based on
n the movement of
specific, identifiable inventory items in and out of stock. This method is applicable when individual
in
items can be
clearly identified, such as with a serial
ial number, stamped receipt date
Formula :
1) Reorder level - It represents thatt llevel of stock of which fresh quantity of material shou
ould be purchased. The
Purchased Quantity will be EOQ.
Reorder level = Maxim
ximum usage x Maximum lead time (Or)
=Minimum le
level + (Average usage x Average Lead time)
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Class note for
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102:COA (Cost Accounting)
2) Minimum Stock Level :It represen
ent Minimum Qty of stock which should be maintained
ed by Organization
Minimum level = Reorder level – (Ave
verage usage x Average lead time)
3) Maximum Stock Level : It represe
sent maximum Qty of stock which should be maintaine
ined by Organization.
Maximum level = Reorder level + Reo
eorder quantity – (Minimum usage x Minimum lead time)
tim
4) Average level = Minimum level +M
Maximum level
(or) Minimum level + ½ Reord
rder quantity
2
5) Danger level (or)
Safety stock level =Minimum usage
e x Minimum lead time (preferred) OR
= Average usage x Average lead time
e OR
= Average usage x Lead time for eme
ergency purposes
6) EOQ (Economic Order Quantity - Wilson’s Formula) = 2AO/C
Where A = Annual usage units
O = Ordering cost per uni
unit
C = Annual carrying cost
st of one unit
i.e. Carrying cast % x Car
arrying cost of unit
ECONOMIC ORDER
DER QUANTITY (EOQ)OR REORDER
QUANTITY (ROQ)
Q)
It represent the
e quantity
qu
of material which should be
purchased each
h time.
tim These quantity is economical
from the angle of the
t storages & ordering cost.
7) Associated cost = Buying cost pa
a + Carrying cost per annam
8) Under EOQ Buying cost = Carryin
ying cost
9) Carrying Cost
= Average inventory x Carrying costt p
per unit pa x Carrying cost % OR
= Average Inventory x Carrying cos
cost per order pa
Where, A = Annu
nnual Consumption of Qty
B = Buying cost
ost OR
O cost of placing one
order.
CS = Cost of storin
oring one unit of material
for 1 year.
If the cost of the
he Investment
In
is given then such
cost also willl be part
p of CS
10) Average inventory = EOQ/2
11) Buying cost = Number of Orders
rs x ordering cost
Note :- Whenever
ever Discount Factor given in a
problem. These
se Formula
F
will not be apply for
calculating EOQ.
OQ.
12) Number of Orders = Annual Dem
emand / EOQ
13) Inventory Turnover (T.O) Ratio = Material consumed
Average Inventory
14) Inventory Turnover Period =
365
.
Inventory Turnover Ratio
15) SafetyStock = Annual Demandx(M
(Maximum lead time - Average lead time)
365
16) Total Inventory cost = Ordering
g ccost + Carrying cost of inventory +Purchase cost
17) Input Output Ratio = Quantity of input of material to production
Standard m
material content of actual output
Remarks : 1) High Inventory Turnover Ratio
io indicates that the material in the question is fast moving
2) Low Inventory Turnover Ratio
o iindicates over investment and locking up of workingCapitall in
i inventories
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
ABC Analysis (or) Pareto Analysis :-
Pareto analysis is a method of
classifying items, events, or
activities according to their
relative importance. It is
frequently used in inventory
management where it is used to
classify stock items into groups
based on the total annual
expenditure for, or total
stockholding cost of, each item.
Organizations can concentrate
more detailed attention on the
high value/important items.
Pareto analysis is used to arrive
at this prioritization.
In this ABC Analysis/Pareto Analysis, materials are categorized into ……..
A-items are goods which annual consumption value is the highest. The top 70-80% of the annual consumption
value of the company typically accounts for only 10-20% of total inventory items.
C-items are, on the contrary, items with the lowest consumption value. The lower 5% of the annual
consumption value typically accounts for 50% of total inventory items.
B-items are the interclass items, with a medium consumption value. Those 15-25% of annual consumption
value typically accounts for 30% of total inventory items.
Particulars
QuantityValue
“A” – Important material
“B” – Neither important nor unimportant
“C” – Un-important
10%
20%
70%
70%
20%
10%
Note:1) Material received as replacement from supplier is treated as fresh supply
2) If any material is returned from Department after issue, it has to be first disposed in the next issue of material
3) loss in the book balance of stock and actual is to be transferred to Inventory adjustment a/c and from there if
the loss is normal it is transferred to Over Head control a/c. If it is abnormal it is transferred to costing profit and
loss a/c.
4) CIF = Cost Insurance and Freight (This consignment is inclusive of prepaid insurance and freight)
5) FOB = Free on Board (Materials moving by sea – insurance premium is not paid)
6) FOR = Free on Rail (Insurance and freight is not borne by the supplier but paid by the company or purchase)
7) For each receipt of goods = Goods Receipt note
8) For each issue of goods = Materials Requisition note (or) Material Issue note
Accounting Treatment :1) Normal Wastage = It should be distributed over goods output increasing per unit cost
2) Abnormal Wastage= It will be charged to costing profit and loss a/c
3) Sale value of scrap is credited to costing profit and loss a/c as an abnormal gain.
4) Sale proceeds of the scrapcan be deducted from material cost or factory overheads.
5) Sale proceeds of scrap may be credited to particular job.
6) Normal Defectives = cost of rectification of defectives should be charged to specific
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102:COA (Cost Accounting)
7) Abnormal Defectives = this should be charged to costing profit and loss a/c
8) Cost of Normal spoilage is to borne by good units
9) Abnormal spoilage should be charged to costing profit and loss a/c
Periodic Inventory System and Perpetual Inventory System
Periodic Inventory - Periodic inventory is a method wherein any inventory sold is physically counted at the end
of an accounting period, deducted from the beginning inventory plus inventory purchases, and the difference
moved to the cost-of-goods-sold (COGS) account. A complete physical counting under a periodic inventory
system is usually done at specific times of the year, such as quarterly or annually, depending on the business.
This is a simple method, but it does not allow the business to maintain accurate information regarding inventory
problems or shortages.
-Inventory account and cost of goods sold are non-existent until the physical count at the end of the year.
-Purchases account is used to record purchases.
-Purchase Return account is used to record Purchases Returns account.
-Cost of goods sold or cost of sale is computed from the ending inventory figure
-For goods returned by customers there are no inventory entries.
Perpetual Inventory Perpetual inventory is the
continuous calculation of
inventory. Businesses update
inventory with each purchase
and deduct inventory after
each sale. This method allows
for an accurate inventory
measurement on a daily basis.
Additionally, the inventory may
be physically counted
frequently throughout this
process to ensure that the
accounting information
matches the physical amount
on hand.
- Account and the balance of costs of goods sold and inventory account exist all the time.
- No individual purchases account but the purchases are recorded in the Inventory Account.
- No individual Purchase Returns account but the purchases return are recorded in the Inventory Account.
- Record cost of goods sold/cost of sale – inventory is reduced when there is a sale.
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GM & Head of ICC, Agarani Bank Limited.
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Class note for
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102:COA (Cost Accounting)
- Returns from customers are recorde
ded by reducing the cost of goods sold and adding bac
ack into inventory.
Inventory Planning:
The process of determining the optima
imal
quantity and timing of inventory for the
purpose of aligning it with sales and
production capacity. Inventory plannin
ing
has a direct impact a company's cash
sh flow
and profit margins especially for small
aller
businesses that rely upon a quick turn
rnover
of goods or materials.
Ordering Cost: Total of expe
penses incurred in placing and order.
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Class note for
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102:COA (Cost Accounting)
Holding Cost / carrying charge
Holding cost is money spent to keep
p and
a maintain a stock of
goods
in storage.
1. Financial and operational expens
nse associated with an
investment.
2. Finance, insurance, security, spoi
poilage, storage, and other
such charges associated with war
arehousing of goods.
3. Interest and lender imposed charg
arges such as negotiation
fee, processing fee, penalties, associated
ass
with a loan.
4. Interest and other charges associ
ociated with goods or
services sold on credit.
EOQ - Economic order quantity is th
the level of inventory that minimizes the total inventor
tory holding costs and
ordering costs. EOQ is that size of th
the order which gives maximum economy in purchasi
sing any material and
ultimately contributes towards maintai
taining the materials at the optimum level and at the minimum
m
cost.In other
words, the economic order quantity
ty (EOQ) is the amount of inventory to be ordered att one
o time for purposes
of minimizing annual inventory cost.
As an example, in a company where order cost is
s estimated
e
at Tk. 10 and
with a holding cost of 25% of item value if annuall demand
d
is 1,000 units at
a supply price of Tk.36, if we substitute these figure
ures in the EOQ formula
then the EOQ is 48 units
Effect of Quantity Discounts
so
on EOQ:
The EOQ-Model of inventory p
problem can determine ordering cycle and
d quantity.
q
When the
purchase unit price is constant,
nt, ordering cycle and ordering quantity, which
ich minimize the one
day's average inventory cost,, is not dependent on the purchase price. But
Bu if purchase price
may change, the EOQ-Modell m
must be modified. The purchase unit price is discounted as the
ordering becomes larger. The
e discount of purchase price is described
d with a decreasing
function of ordering quantity.. This function is not always continuous with
w
respect to the
ordering quantity. Under this co
condition one day's average profit can be defined.
de
And we can
determine ordering cycle and
d o
ordering quantity, which maximize one day's
da
average profit.
Moreover, we consider the situ
ituations under which the setup cost depend
nds on the ordering
quantity. In this case the setup
tup can be described with the increasing function
fu
of ordering
quantity. We show that the EO
EOQ-Model can be applied if it is modified
d by introducing the
continuous setup cost function.
n. This function is not differentiable at some
e levels of ordering
quantity.
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Class note for
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102:COA (Cost Accounting)
Safety Stock and Reorder Point
Safety stock (also called buffer stock) is a term used by logisticians to describe a level of extra stock that is
maintained to mitigate risk of stockouts (shortfall in raw material or packaging) due to uncertainties in supply
and demand.
The reorder point is the level of inventory when a fresh
order should be made with suppliers to bring the
inventory up by the EOQ.
Material Control Methods:
Material is main current asset of business which is needed for finished product. It also has big proportion in total
cost. These two points attract businessman to control the material, so that supply of stock should be continue
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102:COA (Cost Accounting)
without any delay and also it should be at optimum level without any over-stocking problem. For this, cost
accountant has to use following techniques for controlling the material or inventory.
!
#
"
$%
&
!'( !
)* '
(
+
Impact of JIT on Inventory Accounting;
Just-in-time (JIT) is an inventory strategy that strives to improve a business's return on investment by reducing
in-process inventory and associated carrying costs.
-Materials Requirement Planning System.
Question-3: Explain, why the Last in First out (LIFO) is better than First in First out (FIFO) or any other method
of pricing material issues.
Answer-3 : 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 high profit in the income statement
because the cost is also high.
(c) In the case of falling price, profit rise due to less cost, yet the finished goods at market price. i.e. low price.
The profit will decrease.
(d) During the period of inflation, LIFO will show the correct profit.
Question-4: Discuss ABC analysis as a technique of inventory control.
Answer-4 : ABC Analysis as a technique of Inventory Control:
It is a system of inventory control. It exercises control over different items of stores classified on the basis of
cost.It is a system of Inventory control. In this system the items are divided into three categories namely “A”, “B”
and “C” according to their importance, cost, and percentage of usage.
‘A’ category of items (units) consists of only a small percentage i.e. about 10% of total items (units) handles by
the stores but require heavy investment about 70% of inventory value, because of their high price or heavy
requirement or both.
‘B’ category of items (units) are relatively less important – 20% of the total items (units) of material handled by
stores and % of investment required is about 20% of total investment in inventories.
‘C’ category – 70% of total items (units) handled and 10% of value.
Page -38
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Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
For ‘A’ category items (units), stocks levels and EOQ are used and effective monitoring is done.
For ‘B’ category same tools as in ‘A’ category are applied.
For ‘C’ category of items, there is no need of exercising constant control. Orders for items in this group may be
placed after 6 months or once in a year, after ascertaining consumption requirement.
Question-5: Write short notes on Assumptions in calculating EOQ quantity.
Answer-5 : Assumptions in calculating EOQ Quantity
• It is assumed that carrying costs are based on the average inventory
• The annual usage is known and is assumed to be constant.
• The ordering cost per order remains constant and it varies directly with the number of orders.
• The cost per unit to be purchased is known in advance and is assumed to be constant during the year.
Question 06 :
(a) You just joined a company. The company set up a department to deal with stock control.
(b) Your boss asked you to narrate the functions of the stock controller and the importance that this
department must operate efficiently.
Answer-06 :
(a) Function of the stock controller:
· Management of storehouses
· Accepting or rejecting materials after inspection and checking
· Responsibility for the recording of receipts ad issues of materials on the bin cards
· Preparation of purchase requisitions in respect of low stocks
· Issuing materials on the authority of material requisitions
· Responsibility for the safe custody and protection of stock so as to avoid loss and deterioration.
·
·
·
·
(b) Reasons why the stock control function must be efficiently performed:
Production departments need a balanced flow of materials to suit their requirements
Excessive handling must be avoided as this increases the cost but not the value of the goods
Efficient handling improves productivity
Faulty storage leads to deterioration of materials.
Question 07 :
If you should decide to install a system of perpetual inventory and continuous stocktaking, what advantages
would you expect the company to receive?
Answer-07:
· A stricter control of stock helps to reduce the loss due to pilferage and wastage
· Deterioration and other storage faults are detected earlier and losses may be avoided
· Records will provide information for determination of maximum and minimum stock and will enable optimum
order size to be established
· Interim accounts can be prepared without special stocktaking
· With continuous stocktaking the perpetual records can be used and the dislocation of annual stocktaking can
be avoided.
Question-08:Give three problems met in determining the economic order quantity.
(a) The rate of consumption or usage. This can be found by referring to past records or by an
estimate based on production and sales expected in the future
Page -39
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Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
(b) Cost of re-ordering. This is not an easy calculation , due to the variety of work carried out in
the purchasing department for different products and for different purposes, but a figure has to
be placed on the cost of dealing with orders and the expenses of receiving and inspecting the
goods.
(c) The storage and holding cost. This includes the interest on capital invested in stock, together
with other charges such as those of deterioration and obsolescence, insurance and certain
handling costs
Question -09: CMA Examination –Aug-2012 Level-I, COA, Q2(a):
There are 5 Rs in material Management. What these 5Rs stand for? No elaboration is required.
Answer-09: 1. Right quality 2. right quantity 3. right place 4. right time 5. right price
Objectives or goals of purchasing function : Primary objective or goal of purchasing function is making
inputs available to the conversion process at minimum cost to the final output of the company. Thus focus is on
system output rather than on micro level objectives. The inputs to be made available are raw materials, semi
finished items, bought out items etc. There are certain parameters to be monitored for fulfilling the system
objectives. We can call them goals of purchasing. These goals are popularly known as 5R’s of purchase
namely, right price, right quantity, right quality, right place and right time. In simple terms, if the above 5Rs are
achieved primary objective is fulfilled:•
Right Price: Right price is determined by costing the production process of the supplier. Right price is
determined by allowing reasonable profit for the supplier and insisting and helping to reduce cost.
Tender system should be used to identify lowest responsible bidder rather than lowest bidder.
Principles normally used to ensure right price are cost structure and learning curve.
•
Right Quantity: Right quantity of purchase is the one that ensures no excess and no shortage. High
priority items are subjected to EOQ analysis to determine the right quantity for purchase. This ensures
overall minimum cost for inventory.
•
Right Quality: In an item purchased should ensure adhering to mutually accepted standard by supplier
and customer at the time of finalizing the purchase order. The accepted standard may be a drawing, a
sample, a grade or a universal standard like DIN, IS, BS etc.
•
Right Place: is the one where the item is going to enter the value stream. If the item is not available
here, when needed, it is in short supply for the process.
Right Time: is as decided by production schedule for meeting customer’s requirements
•
•
•
•
•
•
•
•
•
•
!
"
#
%
!
" $
&
Page -40
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
•
%
"
"
&
'
" $
•
•
(
(
)
Problem No. 03 :( Materials) - CMA Examination: Level-I , Q: 1 (c ) December-2008 (Marks: 8)
ABC company has obtained the following costs and other data for one of its materials:
Working day per year
Normal use per day
Maximum use per day
Minimum use per day
Lead time
Variable cost of placing one order
Variable carrying cost per unit per year
250
500 units
600 units
100 units
5 days
Tk. 36
Tk. 4
Required: compute the following:
1. Economic order quantity
2. Safety stock (maximum)
3. Order point
4. Normal maximum inventory
5. Absolute maximum inventory
Problem No. 04 :( Materials)
Monyem Ltd. are the manufacturers of picture tubes for T.V. The following are the details of their operation
during 2014:
Average monthly market demand
2,000 Tubes
Inventory carrying cost
20% per annum
Ordering cost
Tk. 100 per order
Cost of tubes
Tk. 500 per tube
Normal usage
100 tubes per week
Minimum usage
50 tubes per week
Maximum usage
200 tubes per week
Lead time to supply
6-8 weeks
Compute from the above:
(1) Economic Order Quantity. If the supplier is willing to supply quarterly 1,500 units at a discount of
5%, is it worth accepting?
(2) Maximum level of stock
(3) Minimum level of stock
(4) Reorder level
Page -41
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Problem No. 05 : (Materials)
Monowar Limited uses a small casting in one of its finished products. The castings are purchased from a
foundry.Monowar Limited purchases 54,000 castings per year at a cost of Tk.800 per casting. The castings are
used evenly throughout the year in the production process on a 360-day-per-year basis. The company
estimates that it costs Tk.9,000 to place a single purchase order and about Tk.300 to carry one casting in
inventory for a year. The high carrying costs result from the need to keep the castings in carefully controlled
temperature and humidity conditions, and from the high cost of insurance. Delivery from the foundry generally
takes 6 days, but it can take as much as 10 days. The days ofdelivery time and percentage of their occurrence
are shown in the following tabulation:
Delivery time (days)
Occurrence
:
:
6
75%
7
10%
8
5%
9
5%
10
5%
Required:
(i) Compute the economic order quantity (EOQ).
(ii) Assume the company is willing to assume a 15% risk of being out of stock. What would be the safety stock?
The re-order point?
(iii) Assume the company is willing to assume a 5% risk of being out of stock. What would be the safety stock?
The re-order point?
(vi) Assume 5% stock-out risk. What would be the total cost of ordering and carrying inventory for one year?
(v) Refer to the original data. Assume that using process re-engineering the company reduces its cost of
placing a purchase order to only Tk. 600. In addition company estimates that when the waste and inefficiency
caused by inventories are considered, the true cost of carrying a unit in stock is Tk.720 per year.
(I)Compute the new EOQ.
(II) How frequently would the company be placing an order, as compared to the old purchasing policy?
Problem No. 06 : (Materials)
The following information is extracted from the store ledger:
Material – B
Date
Descriptions
Feb. 01
Opening stock
Nil
Feb. 01
Purchases
100 units @ Tk. 1 per unit
Feb. 20
Purchases
100 units @ Tk. 2 per unit
Feb. 22
Issues for production
60 units for Job No. W
Feb. 23
Issues for production
60 units for Job No. X
Complete the receipts and issues valuation by adopting the First In First Out (FIFO), Last In Last Out (LIFO)
and the Weighted Average Method.
Problem No. 07 ( Materials)
The books of Farhana AB Ltd. present the following data for the month of August, 2013. Direct labour cost Tk.
17,500 being 175% of works overheads. Cost of goods sold excluding administrative expenses Tk. 56,000.
Inventory accounts showed the following opening and closing balance:
Raw materials
Works in progress
Finished goods
01 –Aug-14
(Tk.)
8,000
10,500
17,600
31-Aug-14
(Tk.)
10,600
14,500
19,000
Page -42
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Other data are :
(Tk.)
3,500
2,500
75,000
Selling expenses
General and administration expenses
Sales for the month
You are required to: (a) Compute the value of materials purchased
(b) Prepare a cost statement showing the various elements of cost and also the profit earned.
Problem No. 08: (Inventory Turnover)
st
The following data are available in respect of material X for the year ended 31 December 2014:
Opening Stock
Tk. 90,000
Purchases during the year
2,70,000
Closing stock
1,10,000
Calculate:
a. Inventory turnover ratio
b. The number of days for which the av
Problem No. 09: (Inventory – E.O.Q)=
About 50 items are required every day for a machine. A fixed cost of Tk. 50 per order is incurred for placing an
order. The inventory carrying cost per item amounts to Tk. 0.02 per day. The lead period is 32 days.
Compute:(a) Economic Order Quantity
(b) Re-order level
Problem No.10: (Application of Cost Concept)
Farhana Ltd. has recorded the following data in the two most recent periods:
Total cost of production
Volume of Production
Tk.
(Units)
14,600
800
19,400
1200
What is the best estimate of the company’s fixed costs per period?
Problem No. 11: (Inventory – E.O.Q)
You are given the following data relating to MMH Ltd.:
Cost of placing each order (i.e. Ordering Cost)
Tk. 4.50
Annual demand (i.e. Annual Consumption)
8,000 units
Stock holding cost as a percentage of average
Stock value (i.e. Inventory Carrying charges)
16%
Price per unit
Tk. 5
Normal lead time
9 days
Safety stock
18 days
Maximum Usage
60 units
From the above, calculate:
(i) What is the quantity that should be ordered each time?
(ii) How many orders should be placed with the supplier during a year?
(iii) What would be the level of stock just before the material which has been ordered is received?
(iv) When should the material be ordered? (under certainty).
Page -43
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Solutions of problem no. 03 : (materials)
Ans. 1. Economic Order Quantity
EOQ = 2AO / C
= 2 x 125,000 x 36 / 4
= 22,50,000
= 1,500 units Ans.
1. Safety stock (maximum)
Maximum use per day …………………………………………………………. 600 units
Normal use per day ………………………………………………….…………… 500 units
Safety stock (Maximum) …………..…………………………………..……… 100 units x 5 days lead time
= 500 unitsAns.
2. Order point
Normal use per day (500 units) x Lead time ( 5 days) ………………………… 2,500 units
Add: Safety stock ……………………………………………………………………. 500 units
Order point ……………………………………………………………………………. 3,000 units
Ans.
3. Normal maximum inventory
Order point …………………………………………………………………………..
Less: Normal use during lead time ……………………………………………….
On hand at time order received …………………………………………………...
Add: Quantity ordered ………………………………………………………….…
Normal maximum inventory ……………………………………………………….
3,000 units
2,500
500 units
1,500
2,000 units Ans.
4. Absolute maximum inventory
Order point …………………………………………………………………………..
Less: Minimum use during lead time …………………………………………...
On hand at time order received …………………………………………………..
Add: Quantity ordered ………………………………………………………….…
Absolute maximum inventory ……………………………… …………………….
3,000 units
500
2,500 units
1,500
4,000 units Ans.
Solutions of problem no. 04 : (materials)
Ans: (1)
S= Annual usage of tubes
= Normal usage per week × 52 weeks = 100 tubes × 52 weeks
Co=Ordering cost per order = Tk.100/- per order
C1=Cost per tube = Tk. 500/iC1=Inventory carrying cost per unit per annum
=20% × Tk.500 = Tk.100/- per unit, per annum
= 5,200 tubes
Economic order quantity:
The supplier is willing to supply 1500 units at a discount of 5%, is it worth accepting
Page -44
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Total cost (when order size is 1500 units) = Cost of 5,200 units + Ordering cost + Carrying cost.
5,200 units
1
=5,200 units × Tk. 475 + ----------------- x Tk. 100 + ------- × 1,500 units × 20% × Tk. 475
1,500 units
2
= Tk. 24,70,000 + Tk. 346.67 + Tk. 71,250=Tk. 25,41,596.67
Total cost (when order size is 102 units)
5,200 units
1
=5,200 units × Tk. 500 + ----------------- x Tk. 100 + ------- × 102 units × 20% × Tk. 500
102 units
2
= Tk. 26,00,000 + Tk. 5,098.03 + Tk. 5,100= Tk. 26, 10,198.03
Since, the total cost under quarterly supply of 1,500 unit with 5% discount is lower than that when order size is
102 units, therefore the offer should be accepted. While accepting this offer consideration of capital blocked
on order size of 1,500 units per quarter has been ignored.
(2)Minimum level of stock=Re-order level + Reorder quantity – Min. usage × Min. reorder period
=1,600 units + 102 units – 50 units × 6 weeks =1,402 units.
(3)Minimum level of stock=Re-order level – Normal usage × Average reorder period
=1,600 units – 100 units × 7 weeks = 900 units.
(4)Reorder level=Maximum consumption × Maximum re-order period
=200 units × 8 weeks =1,600 units
Solutions of problem no. 05 : (materials)
Ans. (I) Computation of economic order quantity (EOQ)
A=Annual requirement = 54,000 castings
C= Cost per casting = Tk. 800
O= Ordering cost = Tk. 9,000 per order
(c × i) = Carrying cost per casting p.a = Tk.300
= 1,800 casting
(ii) Safety stock (Assuming a 15% risk of being out of stock)
Safety stock for one day = 54,000/360 days = 150 castings
Re-order point = Minimum stock level + Average lead time × Average consumption
= 150 + 6 × 150 = 1,050 castings.
(iii) Safety stocks (Assuming a 5% risk of being out of stock)
Safety stock for three days = 150× 3 days = 450 castings
Re-order point = 450 casting + 900 castings = 1,350 castings
Page -45
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
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102:COA (Cost Accounting)
(iv) Total cost of ordering = (54,000/1,800) × Tk. 9,000 = Tk.2,70,000
Total cost of carrying = (450 + ½ × 1,800) xTk.300 = Tk. 4,05,000
(v) (I) Computation of new EOQ:
= 300 castings
(II)Total number of orders to be placed in a year are 180. Each order is to be placed after 2 days (1 year = 360
days). Under old purchasing policy each order is placed after 12 days.
Solutions of problem no. 06 : (materials)
Ans.
Stores Ledger(Material -B)
Under FIFO method
Receipts
Issues
Rate
Rate per
Amou
Qnt.
per
unit
nt
unit
Tk.
Tk.
Unit
Tk.
1.00
100
2.00
200
-
Date
Particulars /
Reference
Feb. 01
Feb. 01
Feb. 20
Opening Balance
Purchases
Purchases
Unit
100
100
Feb. 22
Issues for Job-W
-
-
-
Feb. 23
Issues for Job-X
-
-
-
Qnt.
60
40
Balance
Amou
nt
Tk.
-
1.00
60
1.00
Qnt.
Rate per
unit
Amount
Unit
100
100
100
40
100
80
Tk.
1.00
1.00
2.00
1.00
2.00
2.00
Tk.
100
100
200
40
200
160
40
60
80
2.00
20
Stores Ledger(Material -B)
Under LIFO method
Receipts
Issues
Rate
Rate per
Amou
Qnt.
per
unit
nt
unit
Tk.
Tk.
Unit
Tk.
1.00
100
2.00
200
-
Date
Particulars /
Reference
Feb. 01
Feb. 01
Feb. 20
Opening Balance
Purchases
Purchases
Unit
100
100
Feb. 22
Issues for Job-W
-
-
-
Feb. 23
Issues for Job-X
-
-
-
Qnt.
40
60
2.00
Balance
Amou
nt
Tk.
120
2.00
40
Qnt.
Rate per
unit
Amou
nt
Unit
100
100
100
100
40
80
Tk.
1.00
1.00
2.00
1.00
2.00
1.00
Tk.
100
100
200
100
80
80
80
60
100
1.00
20
20
Page -46
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Date
Particulars /
Reference
Feb. 01
Feb. 01
Feb. 20
Feb. 22
Feb. 23
Opening Balance
Purchases
Purchases
Issues for Job-W
Issues for Job-X
Qnt.
Unit
100
100
-
Stores Ledger (Material -B)
[Under Weighted Average method]
Receipts
Issues
Rate
Amou
Rate per
Amou
Qnt.
per
nt
unit
nt
unit
Tk.
Tk.
Unit
Tk.
Tk.
1.00
100
2.00
200
60
1.50
90
60
1.50
90
Balance
Qnt.
Rate per
unit
Amou
nt
Unit
100
200
140
80
Tk.
1.00
1.50
1.50
1.50
Tk.
100
300
210
120
Solutions of problem no. 07 : (materials)
Ans: (a)Computation of the value of materials purchased
(Tk.)
Cost of goods sold
56,000
Add: Closing stock of finished goods
19,000
75,000
Less: Opening stock of finished goods
17,600
Cost of goods manufactured
57,400
Add: Closing stock of works-in-progress
14,500
71,900
Less: Opening stock of work-in-progress
10,500
Works Cost
61,400
Less: Factory Overhead:
10,000
[ 100/175 of Direct Labour Cost]
Prime Cost
51,400
Less: Direct Labour
17,500
Raw materials consumed
33,900
Add: Closing stock of raw materials
10,600
Raw materials available
44,500
Less: Opening stock of raw materials
8,000
Value of materials purchased
36,500
Ans: (b)Cost Statement showing the various elements of Cost and Profit Earned
Raw material consumed (Refer to Statement (a) above) 33,900
Direct labour cost
17,500
Prime Cost
51,400
Add: Factory Overheads
10,000
Works Cost
61,400
Add: Opening Work-in-progress
10,500
71,900
Less: Closing Work-in-progress
14,500
Cost of goods manufactured
57,400
Add: Opening stock-of finished goods
17,600
75,000
Less: Closing stock of finished goods
19,000
Cost of Goods Sold
56,000
Add: General and administration expenses
Add: Selling expenses
Cost of Sales
Profit (Balance figure Tk.75,000 – Tk.62,000)
Sales
2,500
3,500
62,000
13,000
75,000
Page -47
Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
CMA Professional Level –I
102:COA (Cost Accounting)
Solutions of problem no. 08 (Inventory Turnover)
(a) Inventory Turnover Ratio
= Raw Material Consumed / Average Inventory
= 2,50,000/1,00,000= 2.5 Times
(b) No. of days for which Average inventory is held =Days in a year/ Inventory Turnover Ratio
= 360/2.5 = 144 Days
Notes:
1. Raw material consumed = Opening Stock + Purchases – Closing Stock
= 90,000 + 2,70,000 – 1,10,000= Tk. 2,50,000
2. Average Inventory = (Opening Stock + Closing Stock) / 2
= (90,000 + 1,10,000) / 2= Tk. 1,00,000
Solutions of problem no. 09 : (Inventory – E.O.Q)
(a) EOQ = 2 x A x O / C= [2(50 x 365)] x 50 / (0.02 x 365)= 250,000= 500 units
(b) Re–order level = Maximum Consumption x Maximum Delivery Period= 50 x 32= 1,600 units
Solutions of problem no. 10 : Solution of problem-8: (Application of Cost Concept)
Variable Cost per unit
= Change in Total Cost / Change in Production
= (Tk. 19,400 – Tk. 14,600)/(1,200 units – 800 units)= 4,800/400= Tk. 12 per unit
Total variable cost for 1,200 units = 1,200 units x Tk. 12 = Tk. 14,400
Total fixed cost = Total cost – Total Variable Cost= 19,400 – 14,400= Tk. 5,000
Solutions of problem no.11 : (Inventory – E.O.Q)
(i) Economic Order Quantity is the quantity that should be ordered each time:
EOQ =
Where,
c = Cost of placing each order
d = Annual demand
i = Stock holding cost as a percentage of average stock value
p = Price per unit
2 4.5 8,000
−−−−−−−−−−−
16
−− 5
100
=
=
=
2
−−−
72,000
−−−−−−
0.6 5
90,000
= 300 units.
ii) Number of Orders to be placed in a year =
=
$,%%%
&%%
=
!"#
27 orders.
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Saturday, March 14, 2015
Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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Class note for
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102:COA (Cost Accounting)
(iii) Safety stock is the level of stock immediately before the material ordered is received
Safety Stock = Average Usage x Period for which safety stock is kept
=
$,%%%
&'%
()
x 18 days = 400 units
(iv) When stock reaches the reorder level, material should be ordered.
Reorder Level = Maximum Usage x Maximum Lead Time = 60 x 9 days = 540 units.
The above gives us reorder level under certainty, since the above formula assumes that average usage and
lead time are constant
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Md.Monowar Hossain FCMA,CPA,FCS, ACA
GM & Head of ICC, Agarani Bank Limited.
eMail: md.monowar@gmail.com
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