Amity School of Business Meaning of Material The Institute of Chartered Accountants of India define inventory as: “tangible property held; for sale in the ordinary course of business or; in the process of production for sale or; for consumption in the production of goods and services for sale, including maintenance supplies and consumable other than machinery spares.” 1

Amity School of Business Objectives of Materials Issue Control  Every issue must be authentically authorised.  Proper accounting of every authorised issue.  Proper pricing of material.  Proper charging of material cost to product, process or job. 2

Amity School of Business Methods of pricing materials Cost price methods  Specific Price.  First in First out.  Last in First out.  Base Stock.  Highest in First out.  Next in First out. Average cost price methods  Simple average price.  Weighted average price.  Periodic simple average price. 3  Periodic weighted average price.  Moving simple average.  Moving weighted average price. Notional price methods  Current Standard Price.  Inflated Price.  Replacement price.

Amity School of Business At Cost or Actual Price Method  Specific cost method: Adopted where special types of material are bought for the execution of a job or contract.  The materials to be issued to jobs are identified with the invoices prices and if any handling and inspection costs are to be incurred such expenses are also included to constitute issue prices.  The materials which are thus priced is commonly known as special material as they specifically purchased at the instance of customers. 4

Amity School of Business First-In, First-Out Method (FIFO)  Material received first is issued first.  Assigns the cost of the previous accounting period’s equivalent units in beginning work in progress inventory to the first units completed and transferred out of the process.  Assigns the cost of equivalent units worked on during the current period first to complete beginning inventory, next to start and complete new units and finally in units to ending work in progress.  It follows that units costs are apportioned to cost of production according to their chronological order of receipts. 5

Amity School of Business Advantages of FIFO  As material are issued a actual cost but not on estimates, unrealised profit or loss will not arise.  The value of closing stock will reflect current market price.  For physical issue of materials, this method gives correct cost of material consumed.  It is easy to understand and simple to operate. 6

Amity School of Business Disadvantages of FIFO  Issue prices do not reflect current market price and so does the cost of production.  Two similar jobs cannot be compared as difference rates of material are used to execute the jobs.  During the period of falling prices cost of production will remain high.  During the period of inflation, it will lead to lower cost of sales and higher profits. Suitability : Where there is fast stock turnover or prices remain reasonably stable. 7

Amity School of Business Last In First Out (LIFO)  Material received at last are issued first.  The cost of goods sold and the value of closing inventory is determined only after the final lot of goods is received.  The use of inventory is valued on the basis of the inverse sequence of receipts. 8

Amity School of Business Advantages of LIFO  All issues are priced at actual cost no unrealised profit or loss is derived.  Issue price reflect the current market price and hence the cost of production also conforms to the current market price.  It is possible to fix the current market price.  Because of inflation in the cost of production the reduced profit margin results in savings in tax. 9

Amity School of Business Disadvantages of LIFO  Two similar jobs cannot be compared because of charging different rates of material to different material.  The closing stock does not reflect current market price. This may not be accepted by income tax authorities.  Cannot be operated when the invoice price does not reach before issues are to be priced. Suitability: Easy to operate where purchases are made less frequently, price remain unstable. 10

Amity School of Business Base Stock Method (Minimum Stock): Used by concerns as a safety measures to ensure continuity in production.  Works under the assumption that a certain minimum quantity of materials have to be set aside which will be used during emergency period.  The minimum stock is treated as Base Stock.  Materials in excess of base stock is issued either on the basis of FIFO or LIFO principle. 11

Amity School of Business Highest in first out (HIFO)  A variation of LIFO method.  Issues are priced at the highest rates of material in stock irrespective of dates of purchases. Purpose:  To charge with the highest rate of materials to the current cost of production. Impact :  Cost of production overstated.  Profit understated.  Closing stock is understated. 12

Amity School of Business Next in first out (NIFO)  Issues are priced at the purchased rates of material yet to arrive.  Material are issued at the price at which the new order has been placed. This price will hold good for all future issues until a next order is placed. 13

Amity School of Business Computed Actual Cost Simple average price method  In simple average method, issue price of materials are fixed at average unit price. Simple average is an average of price without considering the quantities involved.  The average price is calculated by dividing the total of the rates of the materials in the stores by the number of rates of prices.  Simple average price = Total unit prices of material in stock Number of purchases 14

Amity School of Business Weighted Average Method ICAI says that…..  A price which is calculated : Total Cost of material in the stock Total quantity of material in stock  It takes into account both the quantity and price of material in the store for determining the issue price.  It is superior to simple average because it recovers the cost price of materials from production.  When the perpetual inventory system is used, the weighted average method is called the Moving Average method. 15

Amity School of Business Advantages of Weighted Price Method  Easy to operate.  In case of high fluctuations in price and quantities purchase lots.  Issue price is not calculated every time, a requisition slip is delivered.  Recovers cost of material from production.  Closing stock reflects a fair value. 16

Amity School of Business Disadvantages of Weighted Average Price  Calls for many calculations when purchases are made frequently.  Issue rate has to be calculated each time when a new purchase is made. 17

Amity School of Business Standard Price  Issues are based on a standard price for a specific period.  Basic standard price: The ideal standard price fixed for long periods so as to help towards planning.  Current standard price: The basic standard price which has been adjusted to provide permanent changes in cost on account of prevailing trends in market. 18

Amity School of Business Inflated Price  Some material are subject to natural wastage such as : material lost due to loading and unloading.  In such cases, the material are issued at an inflated price so as to recover the cost of the natural wastage of material from the production.  In this way the total cost of material is recovered.  Inflated price = Cost of material + Cost of contingencies and other costs. 19

Amity School of Business Market Price/ Replacement Price  Materials are issued at the price at which they can be replaced.  In other words, at the market price prevailing on the date of issue.  Areas of application:  Material purchased in advance for use in large quantities.  Anticipation of economic/ profitable use. 20

Amity School of Business Choice of Methods  Extent of price fluctuations.  Frequency of receipt and issue of materials.  Impact on profit are analysed.  The suitability of the different methods to value inventory is examined.  Managerial policy regarding the valuation of closing stock.  The material should reflect the current market price of the material. 21

Amity School of Business Methods of Costing Job costing Process costing Batch costing Contract costing Unit or Single costing Operations costing

Amity School of Business JOB COSTING A method of cost accounting whereby cost is compiled for a specific quantity of product, equipment repair or other service Examples: printers, machine tool making industries, furniture making concerns, interior decorations, tailoring, painting, automobile repair shop

Amity School of Business Features of Job Costing Dissimilar in nature Production intermittent not continuous Undertaken against customer ’ s orders Industries need not incur selling and distribution expenses Each job treated as a cost unit Work-in-progress differs from period to period according to the number of jobs in hand.

Amity School of Business BATCH COSTING A form of specific order costing where similar articles are manufactured in groups or batches either for sale or use within the undertaking When articles are produced in a group or large number of articles is produced in one setting of the machines or tools because these articles are of the similar nature, design, colour or size Examples: bakery products, hardware, readymade garments, drugs & pharmaceuticals, shoe manufacture

Amity School of Business CONTRACT COSTING A variation of job costing applied in those undertakings which are engaged in constructional and repair work. Variation of job costing – difference lies in the size of the order received Examples: Builders, civil engineering contractors, road repairing concerns, dams & bridge constructional concerns

Amity School of Business Features of Contract Costing Work executed in the premises of contractee and not in factory premises Most contracts involve longer duration for completion Expenses chargeable to contracts are direct in nature Each contract undertaken treated as a cost unit. Payment received depends on stage of completion

Amity School of Business Process Costing A system for applying costs to like products that are mass produced in continuous fashion through a series of production steps called processes Application – in continuous or mass production industries Examples: Oil refineries, fertilizers, breweries, dairy, chemical, sugar, paper, soap

Amity School of Business Features of Process Costing Factory divided into various processes which perform a certain limited operation Finished products uniform in all respects such as shape, size, weight, quality, colour, chemical content Output of one process is the input of the subsequent process Not possible to distinguish finished products while they are in the stage of processing Common to incur normal loss & wastage Usually a single product plant Continuous and large scale production.

Amity School of Business Single or Output or Unit Costing Used in industries where production consists of a single product or a few varieties of the same product with variations in size, shape, quality etc Examples: Brick Works, Sugar Mills, Steel, Cement industries

Amity School of Business Operating or Service Costing Cost of providing a service – operating cost Method of cost ascertainment used in those undertakings engaged in providing services like transport, electricity These undertakings do not manufacture tangible products

Amity School of Business Features of Service Costing Uniformity of service to all Service undertakings do not produce any tangible goods. Instead they render service to the public Cost unit may be simple or composite

Amity School of Business Cost Unit in Operating Costing Simple cost unit –  Transport – per kilometre or per mile  Water Works – per 1000 litres Composite cost unit -  Electricity – per kilowatt hour  Transport – per passenger km or per tonne km  Hospital – per patient day  Cinema – per seat per show or per man show  Hotel – per room day

Amity School of Business Features of Service Costing Uniformity of service to all Service undertakings do not produce any tangible goods. Instead they render service to the public Cost unit may be simple or composite

Amity School of Business Cost Unit in Operating Costing Simple cost unit –  Transport – per kilometre or per mile  Water Works – per 1000 litres Composite cost unit -  Electricity – per kilowatt hour  Transport – per passenger km or per tonne km  Hospital – per patient day  Cinema – per seat per show or per man show  Hotel – per room day