2
MATERIALS
BASIC CONCEPTS AND FORMULAE
1.
Maximum Level: It indicates the maximum figure of inventory quantity held in stock at
any time.
2.
Minimum Level: It indicates the lowest figure of inventory balance, which must be
maintained in hand at all times, so that there is no stoppage of production due to nonavailability of inventory.
3.
Re-order level: This level lies between minimum and the maximum levels in such a way
that before the material ordered is received into the stores, there is sufficient quantity on
hand to cover both normal and abnormal consumption situations.
4.
Danger level: It is the level at which normal issues of the raw material inventory are
stopped and emergency issues are only made.
5.
ABC Analysis: It is a system of inventory control. It exercises discriminating control over
different items of stores classified on the basis of the investment involved. Items are
classified into the following categories:
A Category: Quantity less than 10 % but value more than 70 %
B Category; Quantiy less than 20 % but value about 20 %
C Category: Quantity about 70 % but value less than 10%
6.
Two bin system: Under this system each bin is divided into two parts - one, smaller part,
should stock the quantity equal to the minimum stock or even the re-ordering level, and
the other to keep the remaining quantity. Issues are made out of the larger part; but as
soon as it becomes necessary to use quantity out of the smaller part of the bin, fresh
order is placed.
7.
System of budgets: The exact quantity of various types of inventories and the time
when they would be required can be known by studying carefully production plans and
production schedules. Based on this, inventories requirement budget can be prepared.
Such a budget will discourage the unnecessary investment in inventories.
8.
Perpetual inventory: Perpetual inventory represents a system of records maintained by
the stores department. It in fact comprises: (i) Bin Cards, and (ii) Stores Ledger.
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Materials
9.
Continuous stock verification: Continuous stock taking means the physical checking of
those records (which are maintained under perpetual inventory) with actual stock.
10. Economic Order Quantity (EOQ): It is the calculation of optimum level quantity which
minimizes the total cost of Ordering and Delivery Cost and Carrying Cost.
11. Review of slow and non-moving items: Disposing of as early as possible slow moving
items, in return with items needed for production to avoid unnecessary blockage of
resources.
12. Input output ratio : Inventory control can also be exercised by the use of input output
ratio analysis. Input-output ratio is the ratio of the quantity of input of material to
production and the standard material content of the actual output.
13. Inventory turnover ratio: Computation of inventory turnover ratios for different items of
material and comparison of the turnover rates provides a useful guidance for measuring
inventory performance. High inventory turnover ratio indicates that the material in the
question is a fast moving one. A low turnover ratio indicates over-investment and locking
up of the working capital in inventories
14. Valuation of Material Issues: Several methods of pricing material issues have been
evolved which are as follows:
a)
First-in First-out method: The materials received first are to be issued first when
material requisition is received. Materials left as closing stock will be at the price of
latest purchases.
b)
Last-in First-out method: The materials purchased last are to be issued first when
material requisition is received. Closing stock is valued at the oldest stock price.
c)
Simple Average Method:
Material Issue Price =
d)
Total of unit price of each purchase
Total Numbers of purchases
Weighted Average Price Method: This method gives due weightage to quantities
purchased and the purchase price to determine the issue price.
Weighted Average Price =
Total cost of Materials received
Total Quantity purchases
15. Various Material Losses
a)
Wastage: Portion of basic raw material lost in processing having no recoverable
value
b)
Scrap: The incidental material residue coming out of certain manufacturing
operations having low recoverable value.
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Cost Accounting
c)
Spoilage: Goods damaged beyond rectification to be sold without further
processing.
d)
Defectives: Goods which can be rectified and turned out as good units by the
application of additional labour or other services.
Basic Formulas
1.
Maximum Level = Reorder Level + Reordering Quantity – Minimum Consumption during
the period required to obtain delivery.
Or
RL + RQ – MnC
Or
Safety Stock + EOQ
2.
Minimum Level
=
Reorder Level – (Normal usage per period × Average delivery
time)
3.
Average Stock Level =
Maximum Level + Minimum Level
2
Minimum Level + ½ Reorder Quantity
4.
Reorder Level =
Maximum Reorder period × Maximum Usage
=
Normal Usage × (Minimum Stock Period + Average Delivery Time)
=
Safety Stock + Lead Time Consumption
5.
Danger Level =
Minimum Consumption × Emergency Delivery Time
6.
EOQ =
7.
Ordering Cost =
Annual usage × Fixed Cost per Order
Quantity Ordered
8.
Carrying Cost =
Quantity ordered
× Purchase Price for Inventory × Carrying Cost
2
2 × Annual Consumption × Buying cos t per order
Cost of carrying one unit of inventory for one year
expressed as % of average inventory
9.
Inventory Turnover Ratio =
Material Consumed
Average Inventory
10. Inventory Turnover Period = 365 ÷ Inventory Turnover Ratio
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Materials
11. To decide whether discount on purchase of material should be availed or not, compare
total inventory cost before discount and after discount. Total inventory cost will include
ordering cost, carrying cost and purchase cost.
12. Safety Stock =
Annual Demand
× (Max. lead time – Normal / Average lead time)
365
13. Total Inventory Cost = Ordering Cost + Carrying Cost + Purchase Cost
Note: For calculation of total inventory carrying cost, average inventory should betaken as
half of EOQ. Average inventory cost is normally given as a percentage of cost per unit
Question 1
How are normal and abnormal loss of material arising during storage treated in Cost
Accounts?
(May, 2001)
Answer
Cost Accounts treatment of normal and abnormal loss of material arising during
storage.
The difference between the book balance and actual physical stock, which may either be gain
or loss, should be transferred to Inventory Adjustment Account pending scrutiny to ascertain
the reason for the difference.
If on scrutiny, the difference arrived at is considered as normal, then such a difference should
be transferred to overhead control account and if abnormal, it should be debited to costing
profit and loss account.
In the case of normal losses, an alternative method may be used. Under this method the price
of the material issued to production may be inflated so as to cover the normal loss.
Question 2
Distinguish clearly Bincards and Sores Ledger.
(May, 1999)
Answer
Both bin cards and stores ledger are perpetual inventory records. None of them is a substitute
for the other. These two records may be distinguished from the following points of view:
(i)
Bin card is maintained by the store keeper, while the stores ledger is maintained by the
cost accounting department.
(ii)
Bin card is the stores recording document whereas the stores ledger is an accounting
record.
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Cost Accounting
(iii) Bin card contains information with regard to quantities i.e. their receipt, issue and
balance while the stores ledger contains both quantitative and value information in
respect of their receipts, issue and balance.
(iv) In the bin card entries are made at the time when transaction takes place. But in the
stores ledger entries are made only after the transaction has taken place.
(v) Inter departmental transfer of materials appear only in stores ledger.
(vi) Bin cards record each transaction but stores ledger records the same information in a
summarized form.
Question 3
What is Just in Time (JIT) purchases? What are the advantages of such purchases?
(May, 1999)
Answer
Just in time (JIT) purchases means the purchase of goods or materials such that delivery
immediately precedes their use.
Advantages of JIT purchases:
Main advantages of JIT purchases are as follows:
1.
The suppliers of goods or materials cooperates with the company and supply requisite
quantity of goods or materials for which order is placed before the start of production.
2.
JIT purchases results in cost savings for example, the costs of stock out, inventory
carrying, materials handling and breakage are reduced.
3.
Due to frequent purchases of raw materials, its issue price is likely to be very close to the
replacement price. Consequently the method of pricing to be followed for valuing material
issues becomes less important for companies using JIT purchasing.
4.
JIT purchasing are now attempting to extend daily deliveries to as many areas as
possible so that the goods spend less time in warehouses or on store shelves before
they are exhausted.
Question 4
Discuss the accounting treatment of defectives in cost accounts
(May, 2000)
Answer
Accounting treatment of defectives in cost accounts:
Defectives refers to those units or portions of production, which do not meet the prescribed
specifications. Such units can be reworked or re-conditioned by the use of additional material,
labour and /or processing and brought to the point of either standard or sub-standard units.
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Materials
The possible way of treating defectives in cost accounts are as below:
1.
When defectives are normal and it is not beneficial to identity them job-wise, then the
following methods may be used.
(a) Charged to good products: The cost of rectification of normal defectives is charged to
good units. This method is used when defectives rectified are normal.
(b) Charged to general overheads. If the department responsible for defectives cannot be
identified, the rework costs are charged to general overheads.
(c)
Charged to departmental overheads: If the department responsible for defectives can
be correctly identified, the rectification costs should be charged to that department.
2.
When normal defectives are easily identifiable with specific job the rework costs are
debited to the identified job.
3.
When defectives are abnormal and are due to causes within the control of the
organisation, the rework cost should be charged to the Costing Profit and Loss Account.
Question 5
Discuss the concept of Economic Batch Quantity (EBQ)
(May, 2000)
Answer
Economic batch quantity: Production is usually done in batches and each batch can have
any number of units of a component in it. The optimum quantity for a batch is that quantity for
which the setting up and carrying costs are minimum. Such an optimum quantity is known as
"Economic batch quantity". The formula used to determine the economic batch quantity (EBQ)
is:
EBQ =
where,
2 DS
C
EBQ = Economic batch quantity
D
= Demand of the components in a year
S
= Setting up cost per batch
C
= Carrying cost p.u. per annum
Question 6
Explain the concept of "ABC Analysis" as a technique of inventory control
(May, 2000)
Answer
ABC Analysis: It is a system of selective inventory control whereby the measure of control
over an item of inventory varies with its usage value. It exercises discriminatory control over
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Cost Accounting
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. In other words, the high use value items are controlled more closely than the items of
low use value.
(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.
'A' category of items can be controlled effectively by using a regular system, which ensures
neither over- stocking nor shortage of materials for production. Such a system plans its total
material requirements by making budgets. The stocks of materials are controlled by fixing
certain levels like maximum level, minimum level and re-order level. A reduction in inventory
management costs is achieved by determining economic order quantities after taking into
account ordering cost and carrying cost. To avoid shortages and to minimize heavy
investment of funds in inventories, the techniques of value analysis, variety reduction,
standardization etc. are used along with aforesaid techniques.
In the case of 'B' category of items, as the sum involved is moderate, therefore, the same
degree of control as applied in 'A' category of items is not warranted. The order for the items,
belonging to this category may be placed after reviewing their situation periodically. This
category of items can be controlled by routine control measures.
For 'C' category of items, there is no need of exercising constant control. Orders for items in
this group may be placed either after six months or once in a year, after ascertaining
consumption requirements.
Question 7
Distinguish between Re-order level and Re-order quantity
(November, 2002)
Answer
Re-order level & Re-order quantity: Re-order level is defined as that level of an inventory item
where a fresh order for its replenishment is placed. Mathematically it can be determined by
using the following formulas:
Re-order level (ROL)
= [Maximum consumption x Maximum re-order period]
Alternatively:
Average
⎛ Average rate of
⎞
⎟
= Minimum level + ⎜⎜
×
re − order period ⎟⎠
⎝ consumption
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Materials
Re-order quantity (ROQ) is defined as that quantity of an inventory item for which order is
placed again and again. Economic order quantity is a re-order quantity but not vice-a-versa. It
can be determined by using the following mathematical expression:
EOQ = ROQ =
2 × Annual requirement of inventory item in units × Ordering cos t per order
Annual carrying cos t per unit per annum
Question 8
Describe perpetual inventory records and continuous stock verification.
(May, 2001)
Answer
Perpetual inventory records and continuous stock verification:
Perpetual inventory records represents a system of records maintained by the stores
department. It in fact comprises of (i) Bin cards, and (ii) Stores Ledger.
Bin cards maintains a quantitative record of receipts, issues and closing balances of each item
of stores. Separate bin cards are maintained for each item. Each card is filled up with the
physical movement of goods i.e. on its receipt and issue.
Like bin cards the stores ledger is maintained to record all receipts and issues in respect of
materials. Entries in it are made with the help of goods received notes and material issue
requisitions.
A perpetual inventory record is usually checked by a programme of continuous stock
verification. Continuous stock verification means the physical checking of those inventory
records (which are maintained under perpetual inventory) with actual stock.
Perpetual inventory records helps in proper material control as discrepancies in physical stock
and book figures are regularly reconciled through continuous stock verification.
Question 9
How is slow moving and non-moving item of stores detected and what steps are necessary to
reduce such stocks?
(November, 2001)
Answer
Detection of slow moving and non-moving item of stores:
The existence of slow moving and non-moving item of stores can be detected in the following
ways.
(i)
By preparing and scanning periodic reports showing the status of different items or
stores.
(ii) By calculating the stock holding of various items in terms of number of days/ months of
consumption.
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Cost Accounting
(iii) By computing ratios periodically, relating to the issues as a percentage of average stock
held.
(iv) By implementing the use of a well designed information system.
Necessary steps to reduce stock of slow moving and non-moving item of stores:
(i)
Proper procedure and guidelines should be laid down for the disposal of non-moving
items, before they further deteriorates in value.
(ii) Diversify production to use up such materials.
(iii) Use these materials as substitute, in place of other materials.
Question 10
Distinguish between Bin Card and Stores Ledger.
Answer
Bin Card
Stores Ledger
Bincards are maintained in the stores and are Stores ledger is maintained in the cost accounts
serving the purpose of stock register.
department.
Entries in it are posted by the issue clerk. He
records the quantity about receipts, issues and
closing balance along with code number of
material, maximum, minimum and reorder
levels.
Here entries are posted by the stores ledger
clerk. He records the quantities and value about
receipts, issues and closing balance along with
code number of material, maximum, minimum
and reorder levels.
Here transactions are posted individually.
Here transactions can be posted periodically.
Posting is done at the time of issue of material.
Posting . is done after the issue of materials.
Question 11
Explain the advantages that would accrue in
Using the LIFO method of pricing for the valuation of raw material stock
(May, 2005)
Answer
(a) LIFO- Last-in-first-out: A method of pricing for the valuation of raw material stock. It is
based on the assumption that the items of the last batch(lot) purchased are the first to be
issued. Therefore, under this method, the price of the last batch(lot) of raw material is
used for pricing raw material issues until it is exhausted. If, however, the quantity of raw
material issued is more than the quantity of the latest lot, the price of the last but one lot
and so on will be taken for pricing the raw material issues.
The advantages that would accrue from the use of LIFO method of pricing the valuation
of raw materials, are as follows:2.9
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Materials
(i)
The cost of materials used is nearer to the current market price. Thus the cost of
goods produced depends upon the trend of the market price of materials. This
enables the matching of cost of production with current sales revenues.
(ii)
Use of LIFO during the period of rising prices does not depict unnecessarily high
profit in the income statement; compared to the first-in-first-out or average methods.
The profit shown by the use of LIFO is relatively lower, because the cost of
production takes into account the rising trend of material prices.
(iii) When price of materials fall, the use of LIFO method accounts for rising the profits
due to lower material cost. Inspite of this finished product appears to be more
competitive and at market prices.
(iv) Over a period, the use of LIFO will iron out the fluctuations in profit.
(v) During inflationary period, the use of LIFO will show the correct profit and thus avoid
paying unduly high taxes to some extent.
Question 12
(a) Discuss briefly the considerations governing the fixation of the maximum and minimum
levels of inventory.
(b) A company uses three raw materials A, B and C for a particular product for which the
following data apply :–
Usage
per unit
of
product
(Kgs)
Reorder
Quantity
(Kgs)
Price
per
Kg.
A
10
10,000
B
4
5,000
Raw
Material
Delivery period
(in weeks)
Reorder
level
(Kgs)
Minimum
Average
Maximum
0.10
1
2
3
8,000
0.30
3
4
5
4,750
Rs.
Minimum
level
(Kgs)
C
6
10,000 0.15
2
3
4
2.000
Weekly production varies from 175 to 225 units, averaging 200 units of the said product.
What would be the following quantities:–
(i)
Minimum Stock of A?
(ii)
Maximum Stock of B?
(iii) Re-order level of C?
(iv) Average stock level of A?
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Cost Accounting
Answer
(a) Considerations for the fixation of maximum level of inventory.
Maximum level of an inventory item is its maximum quantity held in stock at any time.
The mathematical formula used for its determination is as follows:
Maximum level = Re-order level – (Minimum Consumption × Minimum Re-order period) +
Re-order quantity.
The important considerations which should govern the fixation of maximum level for
various inventory items are as follows:
(1) The fixation of maximum level of an inventory item requires information about reorder level. The re-order level itself depends upon its maximum rate of consumption
and maximum delivery period. It in fact is the product of maximum consumption of
inventory item and its maximum delivery period.
(2) Knowledge about minimum consumption and minimum delivery period for each
inventory item should also be known.
(3) The determination of maximum level also requires the figure of economic order
quantity. Economic order quantity means the quantity of inventory to be ordered so
that total ordering and storage cost is minimum.
(4) Availability of funds, storage capacity, nature of items and their price also are
important for the fixation of minimum level.
(5) In the case of important materials due to their irregular supply, the maximum level
should be high.
Considerations for the fixation of minimum level of inventory
Minimum level indicates the lowest figures of inventory balance, which must be
maintained in hand at all times, so that there is no stoppage of production due to nonavailability of inventory. The formula used for its calculation is as follows:
Minimum level of inventory = Re-order level – (Average rate of consumption × Average
time of inventory delivery).
The main considerations for the fixation of minimum level of inventory are as
follows:
1.
Information about maximum consumption and maximum delivery period in respect
of each item to determine its re-order level.
2.
Average rate of consumption for each inventory item.
3.
Average delivery period for each item. The period can be calculated by averaging
the maximum and minimum period.
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© The Institute of Chartered Accountants of India
Materials
(b) (i)
Minimum stock of A
Re-order level – (Average rate of consumption × Average time required to obtain
fresh delivery)
=
8,000 – (2,000 × 2) = 4,000 kgs.
(ii) Maximum stock of B
Re-order level – (Minimum Consumption × Minimum Re-order period) + Re-order
quantity
=
4,750 – (4 × 175 × 3) + 5,000
=
9,750 × 2,100 = 7,650 kgs.
OR
(iii) Re-order level of C
Maximum re-order period × Maximum Usage
=
4 × 1,350 = 5,400 kgs.
OR
Re-order level of C
=
Minimum stock of C+(Average rate of consumption × Average time required to
obtain fresh delivery)
=
2,000 + [(200×6)×3] kgs.
=
5,600 kgs.
(iv) Average stock level of A
=
Minimum stock level of A + 21 Re-order quantity
=
4,000 + 21 10,000 = 4,000 + 5,000 = 9,000 kgs.
OR
(v) Average Stock level of A
=
Minimum stock + Maximum stock
(Refer to working note)
2
=
4,000 + 16,250
= 10,125 kgs.
2
Working note
Maximum stock of A = ROL + ROQ – (Minimum consumption × Minimum re-order period)
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Cost Accounting
=
8,000 kgs + 10,000 – [(175×10)×1]
=
16,250 kgs.
Question 13
(a) EXE Limited has received an offer of quantity discounts on his order of materials as
under:–
Price per tonne
Tonnes
Rs.
Nos.
1,200
Less than 500
1,180
500 and less than 1,000
1,160
1,000 and less than 2,000
1,140
2,000 and less than 3,000
1,120
3,000 and above.
The annual requirement for the material is 5,000 tonnes. The ordering cost per order is
Rs. 1,200 and the stock holding cost is estimated at 20% of material cost per annum.
You are required to complete the most economical purchase level.
(b) What will be your answer to the above question if there are no discount offered and the
price per tonne is Rs. 1,500?
(November, 2005)
Answer
(a)
Total Annual
Requirement
(S)
Order
Size
(units)
No. of
Orders
q
S
q
1
2
3
5000 units
400
12.5
Cost of Inventory S
× Per unit cost
Ordering
Cost
Carrying Cost
p.u. p.a.
Total Cost
S × Rs. 1200
q
1 ×q×20% of per unit cost
2
(4+5+6)
Rs.
Rs.
6
7
48,000
60,63,000
Rs.
Rs.
4
5
60,00,000
15,000
(5,000 × Rs.1200)
500
10
1,000
5
59,00,000
(200 × Rs. 240)
12,000
(5,000 × Rs.1180)
58,00,000
2.5
57,00,000
1.666
56,00,000
3,000
59,22,000
2,28,000
59,31,000
(1,000 × Rs. 228)
2,000
(5,000 × Rs.1120)
3,36,000
(1500 × Rs. 224)
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1,16,000
(500 × Rs. 232)
(5,000 × Rs.1140)
3,000
59,71,000
(250 × Rs. 236)
6,000
(5,000 × Rs.1160)
2,000
59,000
59,38,000
Materials
The above table shows that the total cost of 5000 units including ordering and carrying
cost is minimum (Rs. 59,22,000) when the order size is 1000 units. Hence the most
economical purchase level is 1000 units.
2SCo
iC i
(b) EOQ =
Where S is the annual inventory requirement, Co, is the ordering cost
per order and iC1 is the carrying cost per unit per annum.
=
2 × 5000 × Rs.1200
20% × Rs.1500
= 200 tonnes
Question 14
A company has the option to procure a particular material from two sources:
Source I assures that defectives will not be more than 2% of supplied quantity.
Source II does not give any assurance, but on the basis of past experience of supplies
received from it, it is observed that defective percentage is 2.8%.
The material is supplied in lots of 1,000 units. Source II supplies the lot at a price, which is
lower by Rs. 100 as compared to Source I. The defective units of material can be rectified for
use at a cost of Rs. 5 per unit.
You are required to find out which of the two sources is more economical
(May, 2001)
Answer
Comparative Statement of procuring material from two sources
Material source
I
Material source
II
2
2.8
(Future estimate)
(Past experience)
1,000
1,000
20
28
(1,000 units×2%)
(1,000 units ×2.8%)
Additional price paid per lot (Rs.) (A)
100
–
Rectification cost of defect (Rs.) (B)
100
140
(20 units Rs. 5)
(28 units × Rs. 5)
Defective (in %)
Units supplied (in one lot)
Total defective units in a lot
Total additional cost per lot (Rs.): [(A)+(B)]
200
140
Decision: On comparing the total additional cost incurred per lot of 1,000 units, we observe that it
is more economical, if the required material units are procured from material source II.
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© The Institute of Chartered Accountants of India
Cost Accounting
Question 15
What is material handling cost? How will you deal it in cost account?
(May, 1999)
Answer
Material handling cost: It refers to the expenses involved in receiving, storing, issuing and
handling materials. To deal with this cost in cost accounts there are two prevalent approaches
as under:
First approach suggests the inclusion of these costs as part of the cost of materials by
establishing a separate material handling rate e.g., at the rate of percentage of the cost of
material issued or by using a separate material handling rate which may be established on the
basis of weight of materials issued.
Under another approach these costs may be included along with those of manufacturing
overhead and be charged over the products on the basis of direct labour or machine hours.
Question 16
At the time of physical stock taking, it was found that actual stock level was different from the
clerical or computer records. What can be possible reasons for such differences? How will you
deal with such differences?
(May, 1999)
Answer
Possible reasons for differences arising at the time of physical stock taking may be as follows when
it was found that actual stock level was different from that of the clerical or computer records:
(i)
Wrong entry might have been made in stores ledger account or bin card,
(ii)
The items of materials might have been placed in the wrong physical location in the
store,
(iii) Arithmetical errors might have been made while calculating the stores balances on the
bin cards or store-ledger when a manual system is operated,
(iv) Theft of stock.
When a discrepancy is found at the time of stock taking, the individual stores ledger account
and the bin card must be adjusted so that they are in agreement with the actual stock. For
example, if the actual stock is less than the clerical or computer record the quantity and value
of the appropriate store ledger account and bin card (quantity only) must be reduced and the
difference in cost be charged to a factory overhead account for stores losses.
Question 17
G. Ltd. produces a product which has a monthly demand of 4,000 units. The product requires
a component X which is purchased at Rs. 20. For every finished product, one unit of
component is required. The ordering cost is Rs. 120 per order and the holding cost is 10% p.a.
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Materials
You are required to calculate:
(i)
Economic order quantity
(ii)
If the minimum lot size to be supplied is 4,000 units, what is the extra cost, the company
has to incur?
(iii) What is the minimum carrying cost, the company has to incur?
(May, 1999)
Answer
(i)
Economic order quantity:
S
(Annual requirement
= 4,000 units per month × 12 months = 48,000 unit of
Component 'X')
C1
(Purchase cost p.u.)
= Rs.20
Co
(Ordering cost per order)
= Rs.120
i
(Holding cost)
= 10% per annum
E.O.Q. =
2SC 0
iC1
2 × 48,000 units × Rs.120
10% × Rs.20
=
= 2,400 units
(ii) Extra cost incurred by the company
Total cost
= Total ordering cost + Total carrying cost
(when order size is 4,000 units)
=
1
S
× Co + q (iC1)
q
2
=
48,000 units
1
×Rs.120 + × 4,000 units × 10% × Rs.20
4,000 units
2
= Rs. 1,440 + Rs. 4,000 = Rs. 5,440 …(a)
Total cost =
48,000 units
1
×Rs.120 + × 2,400 units × 10% × Rs.20
2,400 units
2
(when order size is 2,400 units) = Rs. 2,400 + Rs. 2,400 = Rs. 4,800 …(b)
Extra cost (a) – (b)
= Rs. 5,440 – Rs. 4,800 = Rs. 640
(incurred by the company)
(iii) Minimum carrying cost:
Carrying cost depends upon the size of the order. It will be minimum on the least order size.
2.16
© The Institute of Chartered Accountants of India
Cost Accounting
(In this part of the question the two order sizes are 2,400 units and 4,000 units. Here 2,400
units is the least of the two order sizes. At this order size carrying cost will be minimum)
The minimum carrying cost in this case can be computed as under:
Minimum carrying cost
=
1
× 2,400 units × 10% × Rs. 20 = Rs. 2,400
2
Question 18
PQR Tubes Ltd. are the manufacturer of picture tubes for T.V. The following are the details of
their operations during 1999-2000.
Ordering cost
Rs. 100 per order
Inventory carrying cost
20% p.a.
Cost of tubes
Rs. 500 per tube
Normal usage
100 tubes per week
Minimum usage
50 tubes per week
Maximum usage
200 tube per week
Lead time to supply
6 – 8 weeks
Required
(i)
Economic order quantity. If the supplier is willing to supply quarterly 1,500 units at a
discount of 5%, is it worth accepting?
(ii)
Re-order level
(iii) Maximum level of stock
(iv) Minimum level of stock
(May, 2000)
Answer
(i)
Economic order quantity (EOQ) =
2 SC 0
iC1
Here S is the annual requirement of tubes, q is the order size
C0 is the ordering cost per order.
iC1 is the inventory carrying cost p.u. p.a.
E.O.Q. =
2 × (100 tubes × 52 weeks) (Rs.100 per order )
20% × Rs.500
2.17
© The Institute of Chartered Accountants of India
Materials
E.O.Q =
2 × 5,200 tubes × Rs.100
= 102 tubes (approx.)
Rs.100
(T.C.)q=102 units = Total purchase cost of 5,200+Total ordering cost + Total carrying cost
= 5,200 units × Rs.500 +
5,200 units
1
× Rs.100 + × 102 units ×Rs. 100
102 units
2
= Rs. 26,00,000 + Rs. 5,098 + Rs. 5,100
= Rs. 26,10,198
Total cost (when the supplier is willing to give a discount of 5% on an order size of 1,500
units) will be:
(TC)q=1,500 units
= 5,200 units × Rs. 475 +
5,200 units
1
× Rs. 100 + ×1,500 units ×
1,500 units
2
20% × Rs.475
= Rs. 24,70,000 + Rs. 346.66 + Rs. 71,250
= Rs. 25,41,596.66 approx.
Decision: Since the total cost of inventory when supplier supplies quarterly 1,500 units at
a discount of 5% is less than that when the order size is of 102 units. Therefore, it is
advisable to accept the offer of 5% discount and save a sum of Rs. 68,601.34
(Rs. 26,10,198 – Rs.25,41,596.66)
Note: In the case of E.O.Q. the total ordering cost and the total carrying cost are always
equal, but in the above case it is not so because of the approximation made in arriving at
the figure of E.O.Q.
(ii) Re-order level (ROL)
=
Maximum usage × Maximum lead time to supply
=
200 tubes per week × 8 weeks
=
1,600 tubes
(iii) Maximum level of stock
=
Re-order level + Re-order quantity – Minimum usage × Minimum lead time to supply
=
1,600 tubes + 102 tubes – 50 tubes × 6 weeks
=
1,402 tubes
(iv) Minimum level of stock
=
Re-order level – Normal usage × Average lead time to supply
=
1,600 tubes – 100 tubes × 7 weeks. =
2.18
© The Institute of Chartered Accountants of India
900 tubes
Cost Accounting
Question 19
Distinguish clearly between bincard and stores ledger.
(May, 2000)
Answer
Distinction between bin card and store ledger.
Both bin card and stores ledger are perpetual inventory records. None of them is a substitute
for the other. These two records may be distinguished from the following points of view:
(i)
Bin card is maintained by the store-keeper, while the cost accounting department
maintains the stores ledger.
(ii)
Bin card is, the stores recording document whereas the stores ledger is an accounting
record.
(iii) Bin card contains information with regard to quantities i.e. their receipt, issue and
balance while the stores ledger contains both quantitative and value information in
respect of their receipts, issue and balance.
(iv) In the bin card entries are made at the time when transaction takes place. But in the
stores ledger entries are made only after the transaction has taken place.
(v) Inter departmental transfers of materials appear only in stores ledger.
(vi) Bin cards record each transaction but stores ledger records the same information in a
summarized form.
Question 20
RST Limited has received an offer of quantity discount on its order of materials as under:
Price per tone
Tones number
Rs. 9,600
Less than 50
Rs. 9,360
50 and less than 100
Rs. 9,120
100 and less than 200
Rs. 8,880
200 and less than 300
Rs. 8,640
300 and above
The annual requirement for the material is 500 tonnes. The ordering cost per order is
Rs.12,500 and the stock holding cost is estimated at 25% of the material cost per annum.
Required
(i)
Compute the most economical purchase level.
(ii)
Compute EOQ if there are no quantity discounts and the price per tonne is Rs.10,500.
(November, 2004)
2.19
© The Institute of Chartered Accountants of India
Materials
Answer
(i)
Cost of
No. of
Order
orders purchase Ax
size (Q)
(Units) A/Q (Units) per unit cost
Carrying cost
A
×Rs.12500
Q
Carrying cost
Q
×C×25%
2
Total cost
(3+4+5)
(1)
(2)
(3)
(4)
(5)
(6)
10
12.5
48,00,000
1,56,250
48,000
50,04,250
(500×9600)
50
10
⎛ 40
⎞
⎜ × 9600 × 0.25 ⎟
⎝ 2
⎠
46,80,000
1,25,000
(500×9360)
100
5
300
2.5
1.67
48,63,500
⎛ 50
⎞
⎜ × 9360 × 0.25 ⎟
⎝ 2
⎠
45,60,000
62,500
(500×9120)
200
58,500
1,14,000
47,36,500
⎛ 100
⎞
× 9120 × 0.25 ⎟
⎜
2
⎝
⎠
44,40,000
31,250
2,22,000
(500×8880)
(2.5×12500)
⎛ 200
⎞
× 8880 × 0.25 ⎟
⎜
2
⎝
⎠
43,20,000
20,875
3,24,000
(500×8640)
(1.67×12500)
46,93,250
46,64,875
⎛ 300
⎞
× 8640 × 0.25 ⎟
⎜
⎝ 2
⎠
The above table shows that the total cost of 500 units including ordering and carrying
cost is minimum (Rs. 46,64,875) where the order size is 300 units. Hence the most
economical purchase level is 300 units.
(ii) EOQ =
2 AO
=
c×i
2 × 500 × 12500
= 69 tonnes.
10500 × 25
Question 21
IPL Limited uses a small casting in one of its finished products. The castings are purchased
from a foundry. IPL Limited purchases 54,000 castings per year at a cost of Rs. 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 Rs.9,000 to place a single
2.20
© The Institute of Chartered Accountants of India
Cost Accounting
purchase order and about Rs.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 of delivery time and percentage of their occurrence are shown in the following tabulation:
Delivery time (days)
:
6
7
8
9
10
Percentage of occurrence
:
75
10
5
5
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?
(iv) 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 Rs.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 Rs. 720 per year.
(a) Compute the new EOQ.
(b)
How frequently would the company be placing an order, as compared to the old
purchasing policy?
(May, 2004)
Answer
(i)
Computation of economic order quantity (EOQ)
(A) Annual requirement
= 54,000 castings
(C) Cost per casting
= Rs. 800
(O) Ordering cost
= Rs. 9,000 / order
(c × i)Carrying cost per casting p.a
= Rs. 300
EOQ =
2 AO
=
c ×i
2 × 54000 × 9000
=
300
(ii) Safety stock
(Assuming a 15% risk of being out of stock)
2.21
© The Institute of Chartered Accountants of India
1800 casting
Materials
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
(iv) Total cost of ordering
= (54,000/1,800) × Rs. 9,000
= Rs. 2,70,000
Total cost of carrying
= (450 + ½ × 1,800) Rs. 300
= Rs. 4,05,000
(v) (a) Computation of new EOQ:
EOQ =
2 × 54,000 × 600
720
= 300 castings
(b) 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.
Question 22
Write short notes on any three of the following:
(i)
Re-order quantity
(ii)
Re-order level
(iii) Maximum stock level
(iv) Minimum stock level
(November, 2003)
Answer
(i)
Re-order quantity: It refers to the quantity of stock for which an order is to be placed at
any one point of time. It should be such that it minimises the combined annual costs ofplacing an order and holding stock. Such an ordering quantity in other words is known as
economic order quantity (EOQ).
EOQ =
2 AO
C×i
A
=
Annual raw material usage quantity
O
=
Ordering cost per order
2.22
© The Institute of Chartered Accountants of India
Cost Accounting
C
=
Cost per unit
i
=
Carrying cost percentage per unit per annum
(ii) Re-order level: It is the level at which fresh order should be placed for the replenishment
of stock.
= Maximum re-order period × Maximum usage
Average time to
⎡ Average
⎤
×
= Minimum level + ⎢
obtain fresh sup plies ⎥⎦
⎣consumption
(iii) Max stock level: It indicates the maximum figure of stock held at any time.
Minimum ⎤
⎡
Minimum
⎢
= Re – order + Re – order – ⎢
× re – order ⎥⎥
consumptio
n
Level
quantity
⎢⎣
period ⎥⎦
(iv) Minimum stock level: It indicates the lowest figure of stock balance, which must be
maintained in hand at all times, so that there is no stoppage of production due to nonavailability of inventory.
= Re– order –
level
⎡
⎢ Average rate of ×
⎢ consumption
⎣
⎤
Average time of ⎥
stock delivery ⎥⎦
Question 23
Discuss ABC analysis as a system of Inventory control.
(November, 2004)
Answer
ABC Analysis as a system of inventory control
It exercises discriminating control over different items of stores classified on the basis of
investment involved.
'A’ category of items consists of only a small %age i.e. approximately 10% of total items
handled by stores but requires heavy investment, about 70% of inventory value, because of
their high prices or heavy requirement or both.
'B’ category of items are relatively less important. They may be approximately 20% of the total
items of materials handled by stores. The %age of investment required is approximately 20%
of total investment in inventories.
'C' category of items do not require much investment. It may be about 10% of total inventory
value but they are nearly 70% of the total items handled by store.
EOQ, re-order level concepts are usually used in case of 'A' category items.
2.23
© The Institute of Chartered Accountants of India
Materials
Question 24
Distinguish between Bin Card and Stores Ledger.
(November, 2004)
Answer
Bin card and stores ledger
Bin card is quantitative record of stores receipt, issue and balance. Control over stock is more
effective, in as much as comparison of actual quantity in hand at any time with the book
balance are possible. Bin cards are kept attached to the bins or quite near thereto , so as to
assist in the identification of stock.
Stores ledger is quantitative and value record of stores receipts, issue and balance. It is a
subsidiary ledger to the main cost ledger. It is maintained by cost accounting deptt.
Question 25
Discuss the accounting treatment of spoilage and defectives in Cost Accounting.
(November, 2003)
Answer
Accounting treatment of spoilage and defectives in Cost Accounting:
Normal spoilage cost (which is inherent in the operation) are included in cost either by
charging the loss due to spoilage to the production order or charging it to production overhead
so that it is spread over all products. Any value realized from the sale of spoilage is credited to
production order or production overhead account, as the case may be.
The cost of abnormal spoilage (i.e. spoilage arising out of causes not inherent in
manufacturing process) is charged to the Costing Profit and Loss Account. When spoiled work
is due to rigid specifications, the cost of spoiled work is absorbed by good production, while
the cost of disposal is charged to production overheads.
The problem of accounting for defective work is the problem of accounting of the costs of
rectification or rework. The possible ways of treatment are as below:
(i)
Defectives that are considered inherent in the process and are identified as normal can
be recovered by using the following methods:
¾ Charged to good products
¾ Charged to general overheads
¾ Charged to department overheads
¾ Charged to identifiable job.
(ii)
If defectives are abnormal and are due to causes beyond the control of organisation, the
rework, cost should be charged to Costing Profit and Loss Account.
2.24
© The Institute of Chartered Accountants of India
Cost Accounting
Question 26
A company manufactures 5000 units of a product per month. The cost of placing an order is
Rs. 100. The purchase price of the raw material is Rs. 10 per kg. The re-order period is 4 to 8
weeks. The consumption of raw materials varies from 100 kg to 450 kg per week, the average
consumption being 275 kg. The carrying cost of inventory is 20% per annum.
You are required to calculate
(i)
Re-order quantity
(iii) Maximum level
(ii)
Re-order level
(iv)
Minimum level
(v) Average stock level
(November, 2002)
Answer
(i)
Reorder Quantity (ROQ)
=
1,196 kgs.
(Refer to working note)
(ii) Reorder level (ROL)
=
Maximum usage × Maximum re-order period
450 kgs × 8 weeks = 3,600 kgs
(iii) Maximum level
(iv) Minimum level
(v) Average stock level
=
Min.
⎛ Min.
⎞
⎟⎟
×
ROL + ROQ – ⎜⎜
⎝ usage re – order period ⎠
=
3,600 kgs + 1,196 kgs – [100 kgs.×4 weeks]
=
4,396 kgs.
=
⎛ Normal Normal
⎞
⎟
ROL – ⎜⎜
×
re – order period ⎟⎠
⎝ usage
=
3,600 kgs. – [275 kgs × 6 weeks]
=
1,950 kgs.
=
1
2
=
1
[4,396 kgs. + 1,950 kgs.] = 3,173 kgs.
2
⎛ Maximum Minimum ⎞
⎟⎟
⎜⎜
+
level
⎠
⎝ level
OR
=
[Minimum level +
2.25
© The Institute of Chartered Accountants of India
1
ROQ]
2
Materials
=
[1,950 kgs +
=
2,548 kgs.
1
× 1,196 kgs.]
2
Working note
Annual consumption of raw material (S) =
14,300 kgs.
(275 kgs. × 52 weeks)
Cost of placing an order (C0)
=
Rs. 100
Carrying cost per kg. Per annum (iC1) =
Economic order quantity (EOQ)
20
× Rs. 10 = Rs. 2
100
=
2SC 0
iC1
=
2 ×14,300 kgs. × Rs.100
= 1,196 Kgs.
Rs. 2
Question 27
The Complete Gardener is deciding on the economic order quantity for two brands of lawn
fertilizer: Super Grow and Nature's Own. The following information is collected.
Fertilizer
Annual Demand
Relevant ordering cost per purchase order
Annual relevant carrying cost per bag
Required:
Super Grow
Nature's Own
2,000 Bags
1,280 Bags
Rs. 1,200
Rs. 1,400
Rs. 480
Rs. 650
(i)
Compute EOQ for Super Grow and Nature's Own.
(ii)
For the EOQ, what is the sum of the total annual relevant ordering costs and total annual
relevant carrying costs for Super Grow and Nature's Own?
(iii) For the EOQ, Compute the number of deliveries per year for Super Grow and Nature's
Own
(November, 1999)
Answer
(i)
EOQ =
2SC 0 *
iC1
2.26
© The Institute of Chartered Accountants of India
Cost Accounting
*Here
S
= Annual demand of fertilizer bags.
C1
= Cost per bag.
C
= Relevant ordering cost per purchase order
iC1
= Annual relevant carrying cost per bag
EOQ for Super Grow Fertilizer
EOQ for Nature's Own Fertilizer
2 × 2,000 bags × Rs.1,200
= 100 bags.
Rs.480
2 × 1,280 bags × Rs.1,400
= 80 bags.
Rs.560
(ii) Total annual relevant costs for Super Grow Fertilizer
=
Total annual relevant ordering costs + Total annual relevant carrying costs
=
S
1
× C 0 + EOQ × iC1
EOQ
2
=
2,000 bags
1
× Rs. 1,200 + × 100 bags × Rs. 480
100 bags
2
=
Rs. 24,000 + Rs. 24,000 = Rs. 48,000
Total annual relevant costs for Nature's Own Fertilizer
=
1,280 bags
1
× Rs. 1,400 + × 80 bags × Rs. 560
80 bags
2
=
Rs. 22,400 + Rs. 22,400 = Rs. 44,800
(iii) Number of deliveries for Super Grow Fertilizer per year.
=
S
(annual demand of fertiliser bags)
EOQ
=
2,000 bags
= 20 orders
100 bags
Numbers of deliveries for Nature's Own fertilizers per year.
=
1,280 bags
= 16 orders
80 bags
Question 28
A Ltd. is committed to supply 24,000 bearings per annum to B Ltd. on a steady basis. It is
estimated that it costs 10 paise as inventory holding cost per bearing per month and that the
set-up cost per run of bearing manufacture is Rs.324.
(i)
What should be the optimum run size for bearing manufacture?
2.27
© The Institute of Chartered Accountants of India
Materials
(ii)
What would be the interval between two consecutive optimum runs?
(iii) Find out the minimum inventory cost per annum.
(November, 2000)
Answer
(i)
Optimum run size for bearing manufacture
=
2 × Annual sup ply of bearings × Set − up cos t per production run
Annual holding cos t per bearing
=
2 × 24,000 bearings × Rs. 324
= 3,600 bearings
12 months × 0.10P
(ii) Interval between two consecutive optimum runs
=
=
=
12 months
⎛ Annual production ⎞
⎜⎜
⎟⎟
⎝ Optimum run size ⎠
12 months
⎛ 24,000 bearings ⎞
⎜⎜
⎟⎟
⎝ 3,600 bearings ⎠
=
12 months
6.66
1.8 months for 55 days approximately.
(iii) Minimum inventory cost per annum
=
Total production run cost + Total carrying cost per annum
=
24,000 bearings
× Rs.324 + (1/2) 3,600 bearings × 0.10P ×12 months
3,600 bearings
=
Rs. 2,160 + Rs. 2,160
=
Rs. 4,320
Question 29
Distinguish between Bin Card and Stores Ledger
(May, 2003)
Answer
Bin card & Stores ledger: Bin card is a quantitative record of stores, receipt, issue and
balance. It is kept for each & every item of store by the store keeper. They are kept attached
to the bins or receptacles or placed quite near thereto so that these also assist in the
identification of stock. Here, the balance is taken out after each receipt or issue transaction.
2.28
© The Institute of Chartered Accountants of India
Cost Accounting
Stores ledger is a collection of cards or loose leaves specially ruled for maintaining a record of
both quantity and cost of stores items received. It also maintains record of stores receipt,
issue and balance in respect of each item of inventory. Entries in this ledger are made from
goods received notes and material requisitions.
Question 30
Discuss the accounting treatment of spoilage and defectives in cost accounting
(May, 2003)
Answer
Accounting treatment of spoilage & defectives in cost accounts:
Normal spoilage (i.e. which is inherent in the operation) costs are included in cost either by
charging the loss due to spoilage to the production order or by charging it to production
overhead so that it is spread over all the products. Any value realized from the sale of
spoilage is credited to production order or production overhead account, as the case may be.
The cost of abnormal spoilage are charged to Costing Profit & Loss Account.
Defectives that are considered inherent in the process and are identified as normal can be
recovered by using any one of the following method.
¾ Charged to good products
¾ Charged to general overheads
¾ Charged to departmental overheads
If defectives are abnormal, they are to be debited to Costing Profit & Loss Account.
Question 31
A company manufactures a product from a raw material, which is purchased at Rs.60 per kg.
The company incurs a handling cost of Rs. 360 plus freight of Rs. 390 per order. The
incremental carrying cost of inventory of raw material is Re. 0.50 per kg. per month. In
addition, the cost of working capital finance on the investment in inventory of raw material is
Rs. 9 per kg. per annum. The annual production of the product is 1,00,000 units and 2.5 units
are obtained from one kg of raw material.
Required
(i)
Calculate the economic order quantity of raw materials.
(ii)
Advise, how frequently should orders for procurement be placed.
(iii) If the company proposes to rationalize placement of orders on quarterly basis, what
percentage of discount in the price of raw materials should be negotiated?
(November, 2001)
2.29
© The Institute of Chartered Accountants of India
Materials
Answer
S
(Annual requirement of raw material in kgs.) = kg. × 1,00,000 units / 2.5 units = 40,000 kgs.
C0
(Handling & freight cost per order) = Rs. 360 + Rs. 390 = Rs. 750
iC1 (Carrying cost per unit per annum + Investment cost per Kg. per annum)
=
(0.5 × 12 months) + Rs. 9 (investment in inventory per kg. per annum)
=
Rs. 15 per unit
(i)
E.O.Q.
=
2 × 40,000 kgs. × Rs. 750
= 2,000 Kgs.
Rs. 15
(ii) Frequency of orders for procurement:
S (Annual consumption)
= 40,000 kgs.
Quantity per order
= 2,000 kgs.
No. of orders per annum
= 20 (40,000 kgs / 2,000 kgs.)
Frequency of placing orders 0.6 months or 18 days (approx.)
(12 months / 20 orders) or 365 days / 20 orders
(iii) Percentage of discount in the price of raw materials to be negotiated:
= 10,000 kgs. Per order
Quarterly orders
(40,000 kgs / 4 orders)
No. of orders
=4
Total cost
(when order size is 10,000 units)
Order placing cost
Rs.3,000
(4 orders × Rs.750)
Carrying cost
Rs.75,000
(10,000/2×Rs.15)
Rs.78,000
Total Cost
(When order size is equal to EOQ)
No. of orders
20
Order placing cost
(20 orders × Rs. 750)
Rs. 15,000
Carrying cost
(2,000/2 × Rs. 15)
Rs. 15,000
Rs.30,000
2.30
© The Institute of Chartered Accountants of India
Cost Accounting
Increase in cost to be compensated by discount:
Rs.48,000
(Rs. 78,000 – Rs. 30,000)
Reduction per kg. In the purchase price of raw material:
Rs. 1.20 per unit
(Rs. 48,000/40,000 Kgs.)
Percentage of discount in the price of raw material to be negotiated : 2% discount
(Rs. 20/60) × 100
Question 32
The quarterly production of a company's product which has a steady market is 20,000 units.
Each unit of a product requires 0.5 Kg. of raw material. The cost of placing one order for raw
material is Rs. 100 and the inventory carrying cost is Rs.2 per annum. The lead time for
procurement of raw material is 36 days and a safety stock of 1,000 kg. of raw materials is
maintained by the company. The company has been able to negotiate the following discount
structure with the raw material supplier.
Order quantity
Discount
Kgs.
Rs.
Upto 6,000
NIL
6,000 – 8,000
400
8,000 – 16,000
2,000
16,000 – 30,000
3,200
30,000 – 45,000
You are required to
4,000
(i)
Calculate the re-order point taking 30 days in a month.
(ii)
Prepare a statement showing the total cost of procurement and storage of raw material
after considering the discount of the company elects to place one, two, four or six orders
in the year.
(iii) State the number of orders which the company should place to minimize the costs after
taking EOQ also into consideration
(May, 2002)
Answer
Working notes
1.
Annual production (units)
80,000
(20,000 units per quarter × 4 quarters)
2.
Raw material required for 80,000 units in kgs.
(80,000 units × 0.5 kgs.)
2.31
© The Institute of Chartered Accountants of India
40,000
Materials
2 × 40,000 kgs. × Rs.100
= 2,000 kgs.
Rs. 2
3.
EOQ =
4.
Total cost of procurement and storage when
the order size is equal to EOQ or 2,000 kgs.
No. of orders
20
(40,000 kgs. / 2,000 kgs.)
Ordering cost (Rs.)
2,000
(20 orders × Rs. 100)
Carrying cost (Rs.)
2,000
(½ × 2,000 kgs. × Rs. 2)
_____
Total cost
4,000
(i)
Reorder point
=
Lead time consumption + Safety stock
=
4,000 kgs. + 1,000 kgs. = 5,000 kgs.
(40,000 kgs. / 360 days) × 36 days.
(ii)
Statement showing the total cost of
procurement and storage of raw materials
(after considering the discount)
Order
size
No. of
orders
Kgs.
(1)
(2)
Total cost of
procurement
Average
stock
Total cost
of storage
of raw
materials
Discoun
t
Total cost
Rs.
Kgs.
Rs.
Rs.
Rs.
(3)=(2)×Rs.10
0
(4)=½×(1)
(5)=(4)×Rs.
2
(6)
(7)=[(3)+(5)–
(6)
40,000
1
100
20,000
40,000
4,000
36,100
20,000
2
200
10,000
20,000
3,200
17,000
10,000
4
400
5,000
10,000
2,000
8,400
6666.66
6
600
3,333
6,666
400
6,866
(iii) Number of orders which the company should place to minimize the costs after
taking EOQ also into consideration is 20 orders each of size 2,000 kgs. The total
cost of procurement and storage in this case comes to Rs. 4,000, which is
minimum.
(Refer to working notes 3 and 4)
2.32
© The Institute of Chartered Accountants of India
Cost Accounting
Question 33
Write short note on perpetual inventory control.
(May, 2006)
Answer
Perpetual Inventory: It represents a system of records maintained by the stores in
department. It in fact comprises 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. Separate bin cards are maintained for each item. Each card is filled up with the
physical movement of goods i.e. on its receipt and issue.
Like bin cards, 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.
A perpetual inventory is usually checked by a programme of continuous stock taking.
Continuous stock taking means the physical checking of those records (which are maintained
under perpetual inventory) with actual stock. Perpetual inventory is essentially necessary for
material control. It incidentally helps continuous stock taking.
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 (a) & (b) above'
(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
book figures
(f)
Making corrective entries were called for after step (e) and
(g) Removing the causes of the discrepancies referred to step (e).
The main advantages of perpetual inventory are as follows :
(1) Physical stocks can be counted and book balances adjusted as and when desired
without waiting for the entire stock-taking to be done.
(2) Quick compilation of Profit and Loss Accounts (for interim period) due to prompt
availability of stock figures.
(3) Discrepancies are easily located and thus corrective action can be promptly taken to
avoid their recurrence.
2.33
© The Institute of Chartered Accountants of India
Materials
(4) A systematic review of the perpetual inventory 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 levels and check of actual balances in hand with these levels
assist the Storekeeper in maintaining stocks within limits and in initiating purchase
requisitions for correct quantity at the proper time.
Question 34
PQR Ltd., manufactures a special product, which requires ‘ZED’. The following particulars
were collected for the year 2005-06:
(i)
Monthly demand of Zed
7,500 units
(ii)
Cost of placing an order
Rs. 500
(iii)
Re-order period
5 to 8 weeks
(iv)
Cost per unit
Rs. 60
(v)
Carrying cost % p.a.
10%
(vi)
Normal usage
500 units per week
(vii)
Minimum usage
250 units per week
(viii) Maximum usage
Required:
750 units per week
(i)
Re-order quantity.
(ii)
Re-order level.
(iii) Minimum stock level.
(iv) Maximum stock level.
(v) Average stock level.
(May, 2006)
Answer
(i)
Re - order quantity =
=
2AO
C×i
2 × 7,500 × 12 × 500
60 × 10
= 3,873 units
(ii) Re-order level
= Maximum re-order period × Maximum usage
= 8 weeks × 750 units per week = 6,000 units
2.34
© The Institute of Chartered Accountants of India
Cost Accounting
(iii) Minimum stock level
= Re-order level – {Normal usage × Average reorder period}
= 6,000 – (500 × 6.5)
= 2,750 units
(iv) Maximum stock level
= Re-order level + Re-order quantity – (Minimum usage × Minimum re-order period)
= 6,000 + 3,873 – (5 × 250)
= 8,623 units
(v) Average stock level
= ½ (Minimum stock level + Maximum stock level)
= ½ (2,750 + 8,623) = 5,687 units
Question 35
Raw materials ‘AXE’ costing Rs. 150 per kg. and ‘BXE’ costing Rs. 90 per kg. are mixed in
equal proportions for making product ‘A’. The loss of material in processing works out to 25%
of the product. The production expenses are allocated at 40% of direct material cost. The
end product is priced with a margin of 20% over the total cost.
Material ‘BXE’ is not easily available and substitute raw material ‘CXE’ has been found for
‘BXE’ costing Rs. 75 per kg. It is required to keep the proportion of this substitute material in
the mixture as low as possible and at the same time maintain the selling price of the end
product at existing level and ensure the same quantum of profit as at present.
You are required to compute the ratio of the mix of the raw materials ‘AXE’ and ‘CXE. (May, 2007)
Answer
Working Notes:
(i)
Computation of material mix ratio:
Let 1 kg. of product A requires 1.25 kg. of input of materials A X E and B X E
Raw materials are mixed in equal proportions.
Then raw material A X E =
1.25
= .625 kg.
2
Then raw material B X E =
1.25
= .625 kg.
2
2.35
© The Institute of Chartered Accountants of India
Materials
(ii) Computation of selling price / kg. of product A
Rs.
Raw material A X E .625 kg. × 150 = Rs. 93.75
Raw material B X E .625 kg. × 90 = Rs. 56.25
Production expenses (40% of material cost)
Total cost
Add: profit 20% of total cost
Selling price
Computation of proportions of materials A X E and C X E in ‘A’
150.00
60.00
210.00
42.00
252.00
Let material C X E required in product A be m kg.
Then for producing 1 kg of product ‘A’, material A X E requirement = (1.25 − m) kg.
To maintain same level of profit and selling price as per Working note (ii), it is required
that the total cost of material in 1 kg. of product A should not exceed
Rs. 150,
i.e., m kg. × Rs. 75 + (1.25 −m) kg. × 150 = Rs. 150
or 75 m + 187.5 – 150 m = 150
or 75 m = 37.5
or m = 0.5 kg.
Raw material A X E requirement in product A = 1.25 – .5 = .75 kg.
So, proportion of material A X E and C X E
= .75 : .50
i.e. 3 : 2.
Question 36
Explain Bin Cards and Stock Control Cards.
(May, 2007)
Answer
Bin Cards and Stores control cards:
Bin Cards are quantitative records of the stores receipt, issue and balance. It is
kept for each and every item of stores by the store keeper. Here, the balance is taken out after
each receipt or issue transaction
Stock control cards are also similar to Bin Cards. Stock control cards contain
further informations as regards stock on order. These cards are kept in cabinets or trays or
loose binders.
2.36
© The Institute of Chartered Accountants of India
Cost Accounting
Question 37
Explain Economic Batch Quantity in Batch Costing.
(May, 2007)
Answer
Economic Batch Quantity in Batch Costing
There are two types of costs involved in Batch Costing(i) set up costs(ii) carrying costs.
If the batch size is increased, set up cost per unit will come down and the carrying cost will
increase. If the batch size is reduced, set up cost per unit will increase and the carry\ng cost
will come down.
Economic Batch quantity will balance both these opponent costs. It is calculated as follows:
EBQ =
2DS
c
Where,
D
=
Annual Demand in units
S
=
Set up cost per batch
C
=
Carrying cost per unit per annum.
Question 38
A Company manufactures a special product which requires a component ‘Alpha’.
following particulars are collected for the year 2008:
(i)
Annual demand of Alpha
:
8,000 units
(ii)
Cost of placing an order
:
Rs. 200 per order
(iii)
Cost per unit of Alpha
:
Rs. 400
The
(iv) Carrying cost % p.a.
: 20%
The company has been offered a quantity discount of 4% on the purchase of ‘Alpha’, provided
the order size is 4,000 components at a time.
Required:
(i)
Compute the economic order quantity.
(ii)
Advise whether the quantity discount offer can be accepted.
Answer
(a)
EOQ =
2 AO
C×i
2.37
© The Institute of Chartered Accountants of India
(November, 2007)
Materials
=
2 × 8,000 × 200
400 × 20%
= 200 units.
Calculation of total inventory cost p.a. at EOQ.
Rs.
32,00,000
Purchase cost = 8,000 × 400
8,000
⎞
⎛A
Ordering cost ⎜ × O =
× 200 ⎟ =
200
⎠
⎝Q
8,000
200
⎞
⎛Q
Carrying cost ⎜ × c × i =
× 400 × 20% ⎟ =
2
⎠
⎝2
8,000
32,16,000
Calculation of total inventory cost p.a. with quantity discount
Rs.
30,72,000
Purchase cost = 8,000 × (400 − 4%)
400
8,000
⎛A
⎞
Ordering cost ⎜ × O =
× 200 ⎟ =
4,000
⎝Q
⎠
________
4,000
⎞
⎛Q
Carrying cost = ⎜ × c × i =
× 384 × 20% ⎟ =
2
⎠
⎝2
1,53,600
32,26,000
Quantity discount offered should not be accepted as it results in increase in total cost of
inventory management by Rs. 10,000.
Question 39
Discuss the treatment of spoilage and defectives in Cost Accounting.
(November, 2007)
Answer
Treatment of spoilage and defectives in Cost Accounting: The normal spoilage cost (i.e.
which is inherent in the operation) are included in cost either by charging the loss due to
spoilage to production order or charging it to production overhead so that it is spread over all
the products. Any value realized from sale of spoilage is credited to production order or
production overhead account, as the case may be. The cost of abnormal spoilage (i.e. arising
out of causes not inherent in manufacturing process) are charged to costing Profit and Loss
Account.
2.38
© The Institute of Chartered Accountants of India
Cost Accounting
The problem of accounting for defective work is that of accounting of the costs of rectification
or rework.
The possible ways of treatment are as under:
For normal defectives:
(i)
Charge to good products.
(ii) Charge to general overheads.
(iii) Charge to departmental overheads
(iv) Charge to Costing Profit and Loss Account if defectives are abnormal and due to causes
beyond the control of organization.
Where defectives are easily identifiable with specific jobs, the works cost are debited to job.
Question 40
(a) The following are the details of receipts and issues of a material of stores in a
manufacturing company for the period of three months ending 30th June, 2008:
Receipts:
Date
Quantity (kgs)
Rate per kg.
(Rs.)
April 10
1,600
5
April 20
2,400
4.90
May 5
1,000
5.10
May 17
1,100
5.20
May 25
800
5.25
June 11
900
5.40
June 24
1,400
5.50
There was 1,500 kgs. in stock at April 1, 2008 which was valued at Rs. 4.80 per kg.
Issues:
Date
Quantity (kgs)
April 4
1,100
April 24
1,600
May 10
1,500
May 26
1,700
June 15
1,500
June 21
1,200
2.39
© The Institute of Chartered Accountants of India
Materials
Issues are to be priced on the basis of weighted average method. The stock verifier of
the company reported a shortage of 80 kgs. on 31st May, 2008 and 60 kgs. on 30th
June, 2008. The shortage is treated as inflating the price of remaining material on
account of shortage.
You are required to prepare a Stores Ledger Account.
(November, 2008)
Answer
(a)
Stores Ledger Account
for the three months ending 30th June, 2008
(Weighted Average Method)
Receipts
Date
GRN
No.
MRR
No.
Qty.
(Kgs.)
Rates
(Rs.)
Issues
Amounts
Requisition. No.
Qty.
(Kgs.)
Balance
Rates Amount
(Rs.)
(Rs.)
Qty.
(Kgs.)
Amount
(Rs.)
Rate for further
Issue (Rs.)
2008
April 1
April 4
1,100
4.80
5,280
1,500
7,200
4.80
400
1,920
4.80
April 10
1,600
5.00
8,000
2,000
9,920
9,920
= 4.96
2,000
April 20
2,400
4.90
11,760
4,400
21,680
21,680
= 4.93
4,400
2,800
13,792
13,792
= 4.93
2,800
3,800
18,892
18,892
= 4.97
3,800
2,300
11,437
11,437
= 4.97
2,300
April 24
May 5
1,600
1,000
5.10
4.93
7,888
5,100
May 10
1,500
4.97
7,455
May 17
1,100
5.20
5,720
3,400
17,157
17,157
= 5.05
3,400
May 25
800
5.25
4,200
4,200
21,357
21,357 = 5.09
4,200
2,500
12,704
12,704
= 5.09
2,500
2,420
12,704
12,704
= 5.25
2,420
3,320
17,564
17,564
= 5.29
3,320
1,820
9,629
9,629
= 5.29
1,820
May 26
1,700
May 31
June 11
Shortage
900
5.40
5.09
8,653
80
4,860
June 15
1,500
2.40
© The Institute of Chartered Accountants of India
5.29
7,935
Cost Accounting
June 21
1,200
June 24
1,400
5.50
5.29
6,348
7,700
June 30
Shortage
60
620
3,281
3,281
= 5.29
620
2,020
10,981
10,981
= 5.40
2,020
1,960
10,981
10,981
= 5.60
1,960
Question 41
The average annual consumption of a material is 18,250 units at a price of Rs. 36.50 per unit.
The storage cost is 20% on an average inventory and the cost of placing an order is Rs. 50.
How much quantity is to be purchased at a time?
Answer
Quantity to be purchased
2 × 18,250 × 50
= 2,50,000 = 500 units
20% of 36.50
Question 42
Discuss the treatment of spoilage and defectives.
Answer
Treatment of spoilage and defectives:
Spoilage: Normal spoilage are included in cost either by charging the loss to the production
order or charging it to production overhead. The cost of abnormal spoilage is charged to
costing profit and loss account.
Defectives:
Normal defectives can be recovered : charged to good production
: charged to general overhead
: charged to department.
If defectives are abnormal and are due to causes beyond the control of organization then they
should be
charged to profit and loss account.
Question 43
Explain, why the Last in First out (LIFO) has an edge over First in First out (FIFO) or any other
method of pricing material issues.
(November, 2007)
2.41
© The Institute of Chartered Accountants of India
Materials
Answer
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.
Question 44
ZED Company supplies plastic crockery to fast food restaurants in metropolitan city. One of
its products is a special bowl, disposable after initial use, for serving soups to its customers.
Bowls are sold in pack 10 pieces at a price of Rs. 50 per pack.
The demand for plastic bowl has been forecasted at a fairly steady rate of 40,000 packs every
year. The company purchases the bowl direct from manufacturer at Rs. 40 per pack within a
three days lead time. The ordering and related cost is Rs. 8 per order. The storage cost is
10% per cent per annum of average inventory investment.
Required:
(i)
Calculate Economic Order Quantity.
(ii)
Calculate number of orders needed every year.
(iii) Calculate the total cost of ordering and storage bowls for the year.
(iv) Determine when should the next order to be placed. (Assuming that the company does
maintain a safety stock and that the present inventory level is 333 packs with a year of
360 working days.
(May, 2008)
Answer
(i)
Economic Order Quantity
EOQ =
=
2×C×O
UI
2 × 40,000 × 8
4
= 1,60,000 = 400 packs.
2.42
© The Institute of Chartered Accountants of India
Cost Accounting
(ii) Number of orders per year
Annual requirements
Economic order quantity
40,000
= 100 order per year
400
(iii) Ordering and storage costs
Rs.
Ordering costs :– 100 orders × Rs. 8.00
800
Storage cost :– (400/2) × (10% of 40)
800
Total cost of ordering & storage
(iv) Timing of next order
1,600
(a) Day’s requirement served by each order.
Number of days requirements =
No. of working days
No. of order in a year
=
360
= 3.6 days supply
100
This implies that each order of 400 packs supplies for requirements of 3.6 days only.
(b) Days requirement covered by inventory
=
∴
Units in inventory
× (Day requirement served by an order)
Economic order quantity
333
× 3.6 days = 3 days requirement
400
(c) Time interval for placing next order
Inventory left for day’s requirement – Lead time of delivery
3 day’s requirements – 3 days lead time = 0
This means that next order for the replenishment of supplies has to be placed
immediately.
Question 45
Discuss ABC analysis as a technique of inventory control.
(May, 2008)
Answer
ABC Analysis as a technique of Inventory Control: It is a system of inventory control. It
exercises discriminating control over different items of stores classified on the basis of
2.43
© The Institute of Chartered Accountants of India
Materials
investment involved. Usually they are divided into three categories according to their
importance, namely, their value and frequency of replenishment during a period.
‘A’ category of items consists of only a small percentage i.e. about 10% of total items 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 are relatively less important – 20% of the total items of material handled
by stores and % of investment required is about 20% of total investment in inventories.
‘C’ category – 70% of total items handled and 10% of value.
For ‘A’ category items, 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 46
The annual carrying cost of material ‘X’ is Rs. 3.6 per unit and its total carrying cost is Rs.
9,000 per annum. What would be the Economic order quantity for material ‘X’, if there is no
safety stock of material X ?
(November, 2008)
Answer
Calculation of Economic Order Quantity
Average Inventory =
Total Carrying Cost
Carrying Cost per unit
=
Rs. 9,000
= 2,500 Units
Rs. 3.60
Economic Order Quantity = Average Inventory × 2
= 2,500 × 2 = 5,000 units.
Alternative Solution:
Total Carrying Cost =
or 9,000 =
Carrying cost per unit × E.O.Q
2
3.6 × E.O.Q
2
or E.O.Q. =
9,000 × 2
= 5,000 unit
3.6
2.44
© The Institute of Chartered Accountants of India
Cost Accounting
Question 47
Differentiate between “scrap” and ”defectives” and how they are treated in cost accounting.
(November, 2007)
Answer
Scrap: Scrap is incidental residence from certain type of manufacture, usually of small amount
and low value, recoverable without further processing.
The cost of scrap is borne by good units and income scrap is treated as other income.
Defectives: Defectives are portion of production which can be rectified by incurring additional
cost. Normal defectives can be avoided by quality control. Normal defectives are charged to
good products.
Abnormal defectives are charged to Costing Profit and Loss Account
Question 48
Following details relating to product X during the month of April, 2009 are available:
Standard cost per unit of X :
Materials
:
50 kg @ Rs.40/kg
Actual production
:
100 units
Actual material cost
:
Rs.42/kg
Material price variance
:
Rs.9,800 (Adverse)
Material usage variance
:
Rs.4,000 (Favourable)
Calculate the actual quantity of material used during the month April, 2009.
Answer
Standard cost of materials for actual output
Rs.
[(100 units × 50 kg) × Rs.40 per kg]
=
Material Usage Variance
2,00,000
4,000 (F)
1,96,000
Material Price Variance
9,800 (A)
Actual cost of materials used
2,05,800
Actual material cost = Rs.42 per kg.
∴ Actual quantity of materials used during the month =
2.45
© The Institute of Chartered Accountants of India
Rs.2,05,800
= 4,900 kg.
42
(May, 2009)
Materials
Alternative solution
Material price variance = Rs. 9800 (A)
Actual price per kg. = Rs. 42
Actual quantity of material used = Rs. 9800/(42-40) = 4900 kg
Question 49
The following information relating to a type of Raw material is available:
Annual demand
2000 units
Unit price
Rs.20.00
Ordering cost per order
Rs.20.00
Storage cost
2% p.a.
Interest rate
8% p.a.
Lead time
Half-month
Calculate economic order quantity and total annual inventory cost of the raw material.
(November, 2009)
Answer
EOQ
=
=
2 × Annual Consumption × Buying Cost per Order
Storage Cost per unit
2 × 2,000 × 20
=
⎛ 2+8⎞
Rs.20 × ⎜
⎟
⎝ 100 ⎠
80,000
= 200 Units
2
Total Annual Inventory Cost
Cost of 2,000 Units @ Rs.20 (2,000 × 20)
No. of Order
2000
200
Ordering Cost 10 × 20
Carrying cost of Average Inventory
200
10
× 20 ×
2
100
2.46
© The Institute of Chartered Accountants of India
=
Rs.40,000
=
Rs.10
=
Rs.200
=
Rs.200
=
Rs.40,400
Cost Accounting
Question 50
Re-order quantity of material ‘X’ is 5,000 kg.; Maximum level 8,000 kg.; Minimum usage 50 kg.
per hour; minimum re-order period 4 days; daily working hours in the factory is 8 hours. You
are required to calculate the re-order level of material ‘X’.
(May, 2010)
Answer
Re-order Level = Maximum Level – [Re-order quantity – (Minimum usage per day × Minimum
Re-order Period)
= 8000 kg. – [5000 kg. – (400 kg* × 4)]
= 8000 kg. – 3400 kg. = 4600 kg.
Hence, Re-order level is 4600 kg.
*Minimum usage per day = 50 kg. × 8 = 400 kg.
Question 51
Which is better plan out of Halsey 50 percent bonus scheme and Rowan bonus scheme for an
efficient worker? In which situation the worker get same bonus in both schemes? (May, 2010)
Answer
Rowan Bonus Scheme pays more bonus if the time saved is below the 50 per cent of time
allowed and if the time saved is more than 50 percent of time allowed then Halsey bonus
scheme pays more bonus. Generally, time saved by a worker is not more than 50 per cent of
time allowed. So, the Rowan bonus scheme is better for an efficient worker. When the time
saved is equal to 50 per cent of time allowed then both plans pays same bonus to a worker.
Bonus under Halsey Plan
=
Standard wage rate × 50/100 × Time saved
...(i)
Bonus under Rowan Plan
=
Standard wage rate ×
Time taken
× Time taken
Time allowed
Bonus under Halsey Plan will be equal to the
Bonus under Rowan Plan when the following condition holds good
= Standard wage rate × 50/100 × Time saved
=
or
Standard wage rate ×
Time taken
× Time saved
Time allowed
1
Time taken
=
2 Time allowed
2.47
© The Institute of Chartered Accountants of India
...(ii)
Materials
or
Time taken =
1
of time allowed.
2
Hence, when the time taken is 50% of the time allowed, the bonus under Halsey and Rowan
Plans is equal.
Question 52
ABC Limited has received an offer of quantity discounts on its order of materials as under:
Price per tonnee
Tonnes
(`)
Nos.
4,800
Less than 50
4,680
50 and less than 100
4,560
100 and less than 200
4,440
200 and less than 300
4,320
300 and above
The annual requirement for the material is 500 tonnes. The ordering cost per order is ` 6,250
and the stock holding cost is estimated at 25% of the material cost per annum.
Required :
(i)
Compute the most economical purchase level.
(ii)
Compute E.O.Q. if there are no quantity discounts and the price per tone is ` 5,250.
(November, 2010)
Answer
(i)
Calculation of most economical purchase level:
A= Annual requirement = 500 tonnes
Order
size
No. of
Orders
Cost of
Purchase
Ordering
Cost
Carrying Cost
Total Cost
(Q)
Units
(A/Q)
(A x
Cost/total)
(A/Q х Rs.
6,250)
(Q/2 x Price/ tonne х
25%)
Rs.
40
× 4,800 × .25 = 24
2
25,02,125
50
× 4,680 × .25 = 29
2
24,31,750
100
× 4,560 × .25 = 57,000
2
23,68,250
40
50
100
500/40= 12.5
500/50= 10
500/100= 5
500 х 4,800
12.5 х 6,250
= 24,00,000
= 78,125
500 х 4,680
10 х 6,250
= 23,40,000
= 62,500
500 х 4,560
5 х 62,250
= 22,80,000
= 31,250
2.48
© The Institute of Chartered Accountants of India
Cost Accounting
200
500/200= 2.5
500 х 4,440=
22,20,000
2.5× х
6,250=15,62
5
200
× 4,440 × .25 = 1,11,000
2
23,46,625
300
500/300=1.67
500 х 4,320
1.67 х 6,250
= 21,60,000
= 10,437.50
23,32,437.50
300
× 4,320 × .25 = 1,62,000
2
The total cost of purchase, ordering cost and carrying cost of 500 tonnes is minimum Rs.
23,32,437.50 when the order size is 300 tonnes. Hence most economical purchase level
is 300 tonnes.
(ii) EOQ =
2AO
2 × 500 tonnes × Rs.6250 per order
=
C×i
Rs.5250 × .25
= 69 tonnes
A is the annual requirement for the material.
O is the ordering Cost per order
Ci is the carrying Cost per unit per annum.
EXERCISE
1
List five types of inefficiency in the use of materials that may be discovered as the result of investigating
material quantity variances. What measures may be taken in each such situation to prevent their
recurrence?
Answer
2.
Many businesses have an unnecessarily large amount of capital locked up in the raw materials and work-inprogress. Indicate methods of correcting this position.
Answer
3
Carriage inwards raw materials
Storage losses
Cash discount received
Insurance costs on stocks of raw materials.
Answer
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Distinguish between spoilage and defectives in a manufacturing company. Discuss their treatment in cost
accounts and suggest a procedure for their control.
Answer
5.
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Discuss briefly how the following items are to be treated in costs:(i)
(ii)
(iii)
(iv)
4
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
What are the conditions that favour the adoption of last-in first-out system of materials pricing? Explain its
working and indicate its advantages and limitations.
2.49
© The Institute of Chartered Accountants of India
Materials
Answer
6
Define (i) Replacement Price and (ii) Standard Price. Discuss the objectives of these methods of pricing of
materials and state the circumstances in which they are used.
Answer
7.
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Distinguish between
(a)
Perpetual Inventory System and continuous stock taking.
(b)
Bill of materials and material requisition note
Answer
10
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
What is ABC analysis? Discuss its role in a sound system of material control.
Answer
9
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Explain the distinction between waste and scrap in the manufacturing process. Discuss their treatment in
cost accounts and suggest a procedure for control.
Answer
8
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Distinguish amongst:
Waste
Spoilage
Salvage
Rectification
Scrap.
How are they treated in Cost Accounts.
Answer
11
Draw a proforma of "Bill of Materials". List down the Advantages of using the same.
Answer
12
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
What is a purchase requisition? Give a specimen form of a purchase requisition.
Answer
17
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Draw specimen draft of a 'Purchase Order'.
Answer
16
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
"To be able to calculate a basic EOQ certain assumptions are necessary. "List down these assumptions.
Answer
15
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Distinguish between perpetual inventory and continuous stock trading.
Answer
14
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Write notes on Bill of Material
Answer
13
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
What do you understand by ABC analysis of inventory control ? A factory uses 4,000 varieties of inventory.
In terms of inventory holding and inventory usage, the following information is compiled:
2.50
© The Institute of Chartered Accountants of India
Cost Accounting
No. of varieties of
inventory
%
% value of inventory holding (average)
% of inventory usage (in
end-product)
3,875
96.875
20
5
110
2.750
30
10
15
0.375
50
85
4,000
100.000
100
100
Classify the items of inventory as per ABC analysis with reasons.
Answer
18
Refer to ‘Chapter No.2 i.e. Material’ of Study Material.
The following transactions in respect of material Y occurred during the six months ended 30th June, 1988
Month
Purchase (Units)
Price per Unit
Rs.
Issued
units
January
200
25
Nil
February
300
24
250
March
425
26
300
April
475
23
550
May
500
25
800
June
600
20
400
(a)
The chief accountant argues that the values of closing stock remains the same no matter which
method of pricing of material issues is used. Do you agree? Why or why not? Detailed stores ledgers
are not required.
(b)
When and why would you recommend the LIFO method of pricing material issues?
Answer (a) Correct (b) At the time of inflation
19
The following information is provided by SUNRISE INDUSTRIES for the fortnight of April, 1988:–
Material Exe :
Stock on 1.4.1988 100 units at Rs. 5 per unit.
Purchases
5-4-88
300 units at Rs. 6
8-4-88
500 units at Rs. 7
12-4-88
600 units at Rs. 8
Issues
6-4-88
250 units
10-4-88
400 units
14-4-88
500 units
Required
2.51
© The Institute of Chartered Accountants of India
Materials
(A)
(B)
Calculate using FIFO and LIFO methods of pricing issues:
(a)
the value of materials consumed during the period
(b)
the value of stock of materials on 15-4-88.
Explain why the figures in (a) and (b) in part A of this question are different under the two methods of
pricing of material issues used. You NEED NOT draw up the Stores Ledgers.
Answer Total value of material Exe consumed during the period under FIFO method comes to (Rs. 1,400 +
Rs. 2,650 – Rs. 3,750) Rs. 7,800 and balance on 15.04.88 is of Rs. 2,800.
Total value of material Exe issued under LIFO method comes to (Rs. 1,500 + Rs. 2,800 + Rs. 4,000) Rs.
8,300
20
About 50 items are required every day for a machine. A fixed cost of Rs. 50 per order is incurred for placing
an order. The inventory carrying cost per item amounts to Rs. 0.02 per day. The lead period is 32 days
compute.
(i)
Economic Order Quantity
(ii)
Re-order level
Answer (i) Economic Order Quantity 500 items
(ii)
21
Re-order level 1,600 items
The following data are available in respect of material X for the year ended 31st March 1997.
Rs.
Opening stock
90,000
Purchases during the year
2,70,000
Closing stock
1,10,000
Calculate –
(i)
Inventory turnover ratio; and
(ii)
the number of days for which the average inventory is held
Answer (i) Inventory turnover ratio 2.5 (ii)
22
the number of days for which the average inventory is held 146 days
M/s Tubes Ltd. are the manufacturers of picture tubes for T.V. The following are the details of their
operation during 1997:
Average monthly market demand
2,000 Tubes
Ordering cost
Rs. 100 per order
Inventory carrying cost
20% per annum
Cost of tubes
Rs. 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:
2.52
© The Institute of Chartered Accountants of India
Cost Accounting
(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
Answer (1) Economic Order Quantity102 tubes (approx.)
23
The offer should be accepted
(2) Maximum level of stock 1,402 units.
(3) Minimum level of stock 900 units.
(4) Reorder level 1,600 units
If the minimum stock level and average stock level of raw-material A are 4,000 and 9,000 units respectively,
find out its 'Re-order quantity'
Answer Re-order quantity = 10,000 units.
24
At what price per unit would Part No. A32 be entered in the Stores Ledger, if the following invoice was
received from a supplier:
Invoice
Rs.
200 units Part No. A32 @ Rs. 5
1,000.00
Less: 20% discount
200.00
Add: Excise Duty @ 15%
120.00
800.00
920.00
Add Packing charges (5 non-returnable boxes)
50.00
970.00
Notes:
(i)
A 2 percent discount will be given for payment in 30 days.
(ii)
Documents substantiating payment of excise duty is enclosed for claiming MODVAT credit.
Answer
25
In a company weekly minimum and maximum consumption of material A are 25 and 75 units respectively.
The re-order quantity as fixed by the company is 300 units. The material is received within 4 to 6 weeks
from issue of supply order. Calculate Minimum level and maximum level of material A.
Answer
26
Cost per unit = Rs. 4.25
Minimum level = 200 units
Maximum level = 600 units
JP Limited, manufacturers of a special product, follows the policy of EOQ (Economic Order Quantity) for
one of its components. The component's details are as follows:
Rs.
Purchase Price Per Component
200
2.53
© The Institute of Chartered Accountants of India
Materials
Cost of an Order
100
Annual Cost of Carrying one Unit in Inventory
10% of Purchase Price
Total Cost of Inventory and Ordering Per
Annum
4,000
The company has been offered a discount of 2% on the price of the component provided the lot size is
2,000 components at a time.
You are required to:
(a)
Compute the EOQ
(b)
Advise whether the quantity discount offer can be accepted.
(Assume that the inventory carrying cost does not vary according to discount policy)
(c)
Would your advice differ if the company is offered 5% discount on a single order?
Answer (a) E.O.Q. = 200 units
27
(b)
The offer should not be accepted
(c)
The offer should be accepted
From the details given below, calculate
(i)
Re-ordering level
(ii)
Maximum level
(iii)
Minimum level
(iv)
Danger level
Re-ordering quantity is to be calculated on the basis of following information:
Cost of placing a purchase order is Rs. 20
Number of units to be purchased during the year is 5,000.
Purchase price per unit inclusive of transportation cost is Rs. 50.
Annual cost of storage per unit is Rs. 5.
Details of lead time:
Average 10 days, Maximum 15 days, Minimum 6 days.
For emergency purchases 4 days.
Rate of consumption:
Answer
28
(i)
Average: 15 units per day, Maximum : 20 units per day.
Re-ordering level = 300 units
(ii)
Maximum level = 440 units
(iii)
Minimum level = 150 units
(iv)
Danger level = 60 units
Write short notes on ABC Analysis
Answer
Refer to ‘Chapter No. 2 i.e. Material’ of Study Material
2.54
© The Institute of Chartered Accountants of India
Cost Accounting
29
The following information is extracted from the Stores Ledger:–
Material X
Opening Stock
Nil
Purchases :
Jan.1 100 @ Re. 1 per unit
Jan. 20
100 @ Rs. 2 per unit
Issues:
Jan. 22
60 for Job W 16
Jan 23
60 for Job W 17
Complete the receipts and issues valuation by adopting the First-in First-Out, Last-in First Out and the
Weighted Average Method. Tabulate the values allocated to Job W 16, Job W 17 and the closing stock
under the methods aforesaid and discuss from the different points of view which method you would prefer.
Answer
Closing Stock (Rs.)
30
FIFO
LIFO
Weighted Average
160
80
120
AT Ltd. furnishes the following stores transactions for September, 1982
1-9-82
Opening balance
4-9-82
Issues Req. No. 85
25 Units value Rs. 162.50
6-9-82
Receipts from B & Co. GRN NO. 26
50 Units @ Rs. 5.75 per unit
7-9-82
Issues Req. No. 97
12 Units
10-9-82
Returns to B & Co.
10 Units
12-9-82
Issues Req. No. 108
15 Units
13-9-82
Issues Req. No.110
20 Units
15-9-82
Receipts from M & Co. GRN NO. 33
25 Units @ Rs. 6.10 per unit
17-9-82
Issues Reg. No. 121
10 Units
19-9-82
Received replacement from B & Co. GRN No. 38
10 Units
8 Units
20-9-82
Returned from department material of M & Co. MRR No.4
5 Units
22-9-82
Transfer from Job 182 to Job 187 in the dept. MTR 6
5 Units
26-9-92
Issues Req. No. 146
29-9-82
Transfer from Dept. "A" to Dept. "B" MTR 10
5 Units
30-9-82
Shortage in stock taking
2 Units
10 units
Write up the priced stores ledger on FIFO method and discuss how would you treat the shortage in stock taking.
Answer
31
Balance Rs. 167.30
A manufacturer of Surat purchased three Chemicals A, B and C from Bombay. The invoice gave the
following information:
Rs.
Chemical A :
3,000 kg @ Rs. 4.20 per kg.
12,600
Chemical B: 5,000 kg @ Rs. 3.80 per kg.
19,000
2.55
© The Institute of Chartered Accountants of India
Materials
Chemical C: 2,000 kg. @ Rs. 4.75 per kg.
9,500
Sales Tax
2,055
Railway Freight
1,000
Total Cost
44,155
A shortage of 200 kg in Chemical A, of 280 kg. in Chemical B and of 100 kg. in Chemical C was noticed due
to breakages. At Surat, the manufacturer paid Octroi duty @ Re 0.10 per kg. He also paid Cartage Rs. 22
for Chemical A, Rs. 63.12 for Chemical B and Rs. 31.80 for Chemical C. Calculate the stock rate that you
would suggest for pricing issue of chemicals assuming a provision of 5% towards further deterioration.
Answer
Rate of issue per Kg
32
A
B
C
Rs.5.20
Rs. 4.68
Rs. 5.76
Shriram Enterprises manufactures a special product "ZED". The following particulars were collected for the
year 1986:
(a)
Monthly demand of ZED-1,000 units.
(b)
Cost of placing an order Rs. 100.
(c)
Annual carrying cost per unit Rs. 15.
(d)
Normal usage 50 units per week
(e)
Minimum usage 25 units per week.
(f)
Maximum range 75 units per week
(g)
Re-order period 4 to 6 weeks.
(3)
Minimum Level
Compute from the above
(1)
Re-order Quantity (2)
(5)
Average Stock Level
Re-order level
(4)
Maximum Level
Answer (1) Re-order Quantity= 186 units
(2)
33
Re-order level = 450 units
(3)
Minimum Level = 200 units
(4)
Maximum Level = 536 units
(5).
Average Stock Level= 368 units
(a)
What is Economic Order Quantity?
Answer Refer to ‘Chapter No.2 i.e. Material’ of Study Material
(b)
The Purchase Department of your organisation has received an offer of quantity discounts on its
order of materials as under:
Price per tonne
Tonnes
Rs.
1,400
Less than 500
1,380
500 and less than 1,000
1,360
1,000 and less than 2,000
1,340
2,000 and less than 3,000
1,320
3,000 and above
The annual requirement of the material is 5,000 tonnes. The delivery cost per order is Rs. 1,200 and
the annual stock holding cost is estimated at 20 per cent of the average inventory.
2.56
© The Institute of Chartered Accountants of India
Cost Accounting
The Purchase Department wants you to consider the following purchase options and advise which
among them will be the most economical ordering quantity, presenting the relevant information in a
tabular form.
The purchase quantity options to be considered are 400 tonnes, 500 tonnes, 1,000 tonnes, 2,000
tonnes and 3,000 tonnes
Answer
34
Most economical order size 1,000 tonnes
Component 'Pee' is made entirely in cost centre 100. Material cost is 6 paise per component and each
component takes 10 minutes to produce. The machine operator is paid 72 paise per hour, and the machine
hour rate is Rs. 1.50. The setting up of the machine to produce the component 'Pee' takes 2 hours 20
minutes.
On the basis of this information, prepare a cost sheet showing the production and setting up cost, both in
total and per component, assuming that a batch of:
(a)
10 components,
(b)
100 components, and
Answer Components
Total Cost (Rs.)
35
1,000 components is produced
10
100
1000
9.48
48.18
435.18
X Ltd. is committed to supply 24,000 bearings per annum to Y Ltd. on a steady basis. It is estimated that it
costs 10 paise as inventory holding cost per bearing per month and that the set-up cost per run of bearing
manufacture is Rs. 324.
(a)
What would be the optimum run size for bearing manufacture?
(b)
Assuming that the company has a policy of manufacturing 6,000 bearing per run, how much extra
costs the company would be incurring as compared to the optimum run suggested in (a) above?
(c)
What is the minimum inventory holding cost?
Answer
(c)
36
(c)
(a)
3,600 bearings.
(b)
Extra Cost incurred = Rs. 576
Minimum inventory holding cost = Rs. 2,160
Raw materials 'X' costing Rs. 100 per kilogram and 'Y’ costing Rs. 60 per kilogram are mixed in equal
proportions for making product 'A'. The loss of material in processing works out to 25% of the output. The
production expenses are allocated at 50% of direct material cost. The end product is priced with a margin of
33 1 % over the total cost. Material 'Y' is not easily available and substitute raw material 'Z' has been found
3
for 'Y’ costing Rs. 50 per kilogram. It is required to keep the proportion of this substitute material in the
mixture as low at possible and at the same time maintain the selling price of the end product at existing
levels and ensure the same quantum of profit as at present.
You are required:
To compute what should be the ratio of mix of the raw materials X and Z.
Answer
The ratio of mix of the raw materials X and Z =3:2.
2.57
© The Institute of Chartered Accountants of India
Materials
37 SK Enterprise manufactures a special product “ZE”. The following particulars were collected for the year 2004:
Annual consumption
12,000 units (360 days)
Cost per unit
Re. 1
Ordering cost
Rs. 12 per order
Inventory carrying cost
24%
Normal lead time
15 days
Safety stock
30 days consumption
Required:
(i)
Re-order quantity
(ii)
Re-order level
(iii)
What should be the inventory level (ideally) immediately before the material order is received?
Answer
38
(i)
Re-order quantity = 1095.4 units or say 1,100 units
(ii)
Re-order level = 1,500 units
(iii)
The inventory level (ideally) immediately before the material order is received = 1,000 units.
PQR Limited produces a product which has a monthly demand of 52,000 units. The product requires a
component X which is purchased at Rs. 15 per unit. For every finished product, 2 units of Component X are
required. The Ordering cost is Rs. 350 per order and the Carrying cost is 12% p.a.
Required:
(i)
Calculate the economic order quantity for Component X.
(ii)
If the minimum lot size to be supplied is 52,000 units, what is the extra cost, the company has to
incur?
(iii)
What is the minimum carrying cost, the Company has to incur?
Answer
39
economic order quantity = 15,578 units of components
Extra cost incurred = Rs 22,960
(iii)
Minimum carrying cost = Rs 14,020
The rate of interest is 12%, the price per unit is Rs. 50, the number of units required in a year is 5,000 and the cost
of placing one order and receiving the goods once is Rs. 54. How much should be purchased at a time ?
Answer
40
(i)
(ii)
300 units
The following is the record of an item in a stores ledger
Units
Amount
Units
Rs.
10,000
20,000
Amount
Rs.
Jan. 1
To Balance b/d
Jan. 10
To Purchase
5,000
12,000
Feb. 8
By Issue
6,000
15,000
Feb. 3
To Purchase
20,000
55,000
Mar. 15
By Issue
22,000
60,000
Mar. 10
To Purchase
10,000
30,000
Mar. 31
By Bal. C/d
3,000
12,000
45,000
1,17,000
45,000
1,17,000
2.58
© The Institute of Chartered Accountants of India
Jan. 15
By Issue
14,000
30,000
Cost Accounting
Comment upon the method followed to price the issues. Find out the value of closing stock assuming issue
to have been made for period on (i) FIFO basis, (ii) LIFO basis, and (iii) Weighted average basis.
Answer
41
(i)
Rs. 9,000
(ii)
Rs. 7,500
(iii)
Rs. 8,497
A company ordered 54 tonnes of coal from a colliery. The invoice was for Rs. 1,000, the freight being Rs.
300. The actual quantity received was 52 tonnes. What should be the price per tonne ?
Ten tonnes of coal were destroyed by an accident quantity received was 52 tonnes. How should be the loss
be treated?
Answer
42
In a section of ready-made garments factory the monthly wages and overhead respectively amounted to Rs.
5,875 and Rs. 3,650. In a period 10,000 metres of cloth were introduced out of which 600 metres still
remained in stock. It takes 2 metres to make the garments but in the month, the total output was 4,500
garments. The cost of the cloth is Rs. 3.50 per metre. Ascertain the cost of garment, assuming cuttings
were sold for Rs. 125.
Answer
43
Rs. 25; Debit Costing Profit and Loss A/c Rs. 250.
Cost Rs. 9.09 per unit; loss debited to Costing Profit and Loss A/c 1,400.
The purchase Department of your organisation has received an offer of quantity discounts on its orders of
materials as under:
Price per tonne
Rs.
1,400
Tonnes
Nos.
Less than 500
1,380
500 and less than 1,000
1,360
1,000 and less than 2,000
1,340
2,000 and less than 3,000
1,320
3,000 and above.
The annual requirement for the material is 5,000 tonnes. The delivery cost per order is Rs. 1,200 and the
annual stock holding cost is estimated at 20% of the average inventory.
The Purchase Department wants you to consider the following purchase options and advise which among
them will be the most economical ordering quantity, presenting the relevant information in a tabular form.
The purchase quantity options to be considered are 400 tonnes, 500 tonnes, 1,000 tonnes, 2,000 tonnes
and 3,000 tonnes.
Answer
45
Most economical order size is 1,000 tonnes.
Component ‘Pee’ is made entirely in cost centre 100. Material cost is 6 paise per component and each
component takes 10 minutes to produce. The machine operator is paid 72 paise per hour, and the machine
hour rate is Rs. 1.50. The setting up of the machine to produce the component ‘Pee’ takes 2 hours 20
minutes.
On the basis of this information, prepare a cost sheet showing the production and setting up cost, both in
total and per component, assuming that a batch of:
2.59
© The Institute of Chartered Accountants of India
Materials
(a)
10 components,
(b)
100 components, and
(c)
1,000 components is produced.
Answer
Total cost (Rs. 9.48; Rs. 48.18; Rs. 435.18) and per component cost is (Rs. 0.948; Rs. 0.4818
and Rs. 0.43518) respectively when the batch size is 10,100 and 1,000 components.
46
From the details given below, calculate:
(i)
Re-ordering level (ii)
Maximum level
(iii)
Minimum level
(iv)
Danger level
Re-ordering quantity is to be calculated on the basis of following information.
-
cost of placing a purchase order is Rs. 20
-
Number of units to be purchased during the year is 5,000.
-
Purchase price per unit inclusive of transportation cost is Rs. 50
-
Annual cost of storage per unit is Rs. 5
-
Details of lead time :
-
Rate of consumption
Average 10 days, Maximum 15 days, Minimum 6 days. For emergency purchase 4 days.
Average : 15 units per day.
Minimum : 20 units per day.
Answer
(i)
ROL
= 300 units.
(ii)
Maximum level
= 440 units
(iii)
Minimum level
= 150 units
(iv)
Danger level
=
60 units.
2.60
© The Institute of Chartered Accountants of India