Unit 2 

MATERIAL COSTING

2.1 Material Cost

Material is any substance (Physics term) that forms part of or composed of a finished product. i.e. material refers to the commodities supplied to an undertaking for the purpose of consumption in the process of manufacturing or of rendering service or for transformation into products. The term ‘Stores’ is often used synonymously with materials, however, stores has a wider meaning and it covers not only raw materials consumed or utilized in production but also such other items as sundry supplies, maintenance stores, fabricated parts, components, tools, jigs, other items, consumables, lubricants etc. Finished and partly finished products are also often included under the term ‘Stores’. Materials are also known as Inventory. The term Materials / Inventory covers not only raw materials but also components, work-in-progress and finished goods and scrap also.

Material cost is the significant constituent of the total cost of any product. It constitutes 40% to 80% of the total cost. The percentages may differ from industry to industry. But for manufacturing sector the material costs are of greatest significance. Inventory also constitutes a vital element in the Working Capital. So it is treated as equivalent to cash. Therefore, the analysis and control on Material Cost is very important.

2.2 Objectives of Material Control System

Material Control: The function of ensuring that sufficient goods are retained in stock to meet all requirements without carrying unnecessarily large stocks.

The objectives of a system of material control are as following: -

1. To make continuous availability of materials so that there may be uninterrupted flow of materials for production. Production may not be held up for want of materials.
2. To purchase requisite quantity of materials to avoid locking up of working capital and to minimize risk of surplus and obsolete stores.
3. To make purchase competitively and wisely at the most economical prices so that there may be reduction of material costs.
4. To purchase proper quality of materials to have minimum possible wastage of materials.
5. To serve as an information centre on the materials knowledge for prices, sources of supply, lead time, quality and specification.
6. Study of Material can be better explained as follows:

Material Purchase & ReceiptStorageIssue – Control

2.3 Requisites of Material Control System

1. Coordination and cooperation between the various departments concerned viz purchase,
2. Receiving, inspection, storage, issues and Accounts and Cost departments.
3. Use of standard forms and documents in all the stages of control.
4. Classification, coordination, standardization and simplification of materials.
5. Planning of requirement of material.
6. Efficient purchase organization.
7. Budgetary control of purchases.
8. Planned storage of materials, physical control as well as efficient book control through satisfactory storage control procedures, forms and documents.
9. Appropriate records to control issues and utilization of stores in production.
10. Efficient system of Internal Audit and Internal Checks.
11. System of reporting to management regarding material purchase, storage and utilization.

2.4 Purchase Flow

The main functions of a purchase department are as follows: -

1. What to purchase? – Right Material with good quality
2. When to purchase? – Right Time
3. Where to purchase? – Right Source
4. How much to purchase? – Right Quantity
5. At what price to purchase? – Right Price

To perform these functions effectively, the purchasing department follows the following procedure: -

1. Receiving purchase requisitions.
2. Exploring the sources of supply and choosing the supplier.
3. Preparation and execution of purchase orders.
4. Receiving materials.
5. Inspecting and testing materials.
6. Checking and passing of bills for payment

2.5 Purchase Organization

Purchasing involves procurement of materials of requisite quantity and quality at economic price. It is of extreme importance particularly to a manufacturing concern because it has bearing on all vital factors of manufacture such as quantity, quality, cost, efficiency, economy, prompt delivery, volume of production and so on. Purchase department in a business concern can be organized into two types i.e. Centralized Purchasing System and De-Centralized Purchasing System. Purchasing process in most of the organisation is a centralized function because the advantages of a centralized purchasing out weight its disadvantages. Lets us see the merits and demerits of both the systems.

2.6 Merits of a centralized & De-merits of decentralized purchase organization

1. When materials are purchased favorable terms (Trade discount, Economies of transport...etc) can be obtained because the quantity involved will be large. In case of decentralized system these benefits cannot be realized.
2. Specialized purchasing officer can be appointed with the specific purpose of highly efficient purchases functions of the concern. In case of decentralized purchase system, the business entity cannot afford a specialized purchasing officer in every location.
3. Effective control can be exercised over the stock of materials because duplication of purchase of the same materials may easily be avoided in centralized purchase system, where as in decentralized purchase system, duplication of purchase of same material cannot be avoided.
4. Under centralized purchase system effective control can be exercised on the purchases of all the materials as the purchase function is channelized through one track which would make the system of receiving, checking and inspection efficient. Where as in decentralized purchase system it is very difficult to exercise controls.
5. Under centralized system of purchase materials, components and capital equipments can be suitably standardized so that the maximum purchasing benefits be availed of, storage facilities can be improved and available production facilities can be greatly utilized to the maximum possible extent. Under decentralized purchase system standardization of materials, storage facilities. Etc is very difficult to achieve.
6. Under centralized system of purchase closer cooperation between the financial and purchasing departments can be achieved which may not be easy under decentralized purchase system.

2.7 De-Merits of a centralized & Merits of decentralized purchase organization

1. In may take unnecessarily long time to place a purchase order under centralized purchase system because to collect the relevant data from various departments/ branches/locations may take more time. These delays can be avoided under decentralized purchase system.
2. In case of centralized purchasing system, branches at different places cannot take advantage of localized purchasing, whereas under decentralized purchase system localization savings can be realized.
3. Due to the Chances of misunderstanding / miscommunication between the branch and the centralized purchasing office may result in wrong purchase of material also. Whereas under decentralized purchase system, the chances of miscommunication/ misunderstanding are very limited.
4. Centralized system will lead to high initial costs because a separate purchasing department for purchase of materials is to be setup. No such costs are required to be incurred in the decentralized system.
5. Replacement of a defective item may take long time resulting in strain on smooth production flow under centralized system of purchase. No such delay in decentralized system.

Now let us see the various material control documents in detail.

2.8 Purchase Requisition

Purchases Requisition is a request made to the Purchase Department to procure materials of given description and of the required quality and quantity within a specified period. It is a formal request and it authorizes the Purchase Department to issue a Purchase Order to secure materials intended for periodic requirements of a given material or materials to provide guidance to the Purchase Department to estimate the future requirements in order to secure maximum purchase benefits in the form of higher discount and better credit terms. The extent and range of materials requirements provide a basis for preparation of a purchase budget. The actual requirements of a given period can be summarized from the purchases requisition and compared with the purchase budget in order to determine the variances and the reasons thereof. This form is prepared by storekeeper for regular items and by the departmental head for special materials not stocked as regular items.

The Purchase Requisition is prepared in three copies. Original will be sent to Purchase department, Duplicate copy will be retained by the indenting (request initiating) department and the triplicate will be sent to approver for approving the purchase requisition.

Purchase Requisition provides the three basic things: -

1. What type of material is to be purchased?
2. When to be purchased?
3. How much is to be purchased?

The specimen form of Purchase Requisition is as shown below:

2.9 Purchase Order

Purchase Order (PO) is a request made in writing to selected supplier to deliver goods of requisite quality, quantity, (as per the purchase requisition) at the prices, terms and conditions agreed upon. It is a commitment on the part of the purchaser to accept the delivery of goods contained in the Purchase Order if the terms included therein, are fulfilled. Purchase Order contains the following details: -

(a) Purchase Order No; (b) PO Date; (c) Supplier Name and Address; (d) Material Code; (e) Material description; (f) Grade & Other particulars of the material; (g) Quantity to be supplied; h) Price; i) Place of delivery; j) Taxes; k) Terms of Payment (Credit period) etc

Usually a purchase order is made in five copies, one each for suppliers, Receiving/Stores Department, Originating Department, Accounts Department and filing. Thus we see that all the departments concerned with the materials are informed fully about all the details of every purchases and it becomes easier for everyone to follow up on any relevant matter.

2.10 Receipt & Inspection of Materials

Goods Received cum Inspection Note:

The stores department will receive the material after the gate entry. It will compare the quantities received with the PO Quantity. It is a valuable document as it forms the basis of accounting entry in the stores ledger and stock records. It is the document basis for quality control department to carry inspection of the material in warded.

It also forms the basis of payments to be made to the supplier in respect of the materials supplied by him. Suppliers invoices are checked with goods received notes which such for actual receipt of the goods supplied by the supplier. One copy of such note is also sent to Inspection Department who after inspection of materials approves the note for Stores Department to receive the materials. Outstanding Goods Received Notes which are not linked with supplier’s bills enable the Accounts Department to estimate at the year end the liability for goods purchased for which supplier’s bills not received.

The specimen copy of the Goods Received cum Inspection Note as below:

2.11 Purchase Quantity

Important requirement for an efficient system of purchase control is to ensure that only the correct quantity of materials is purchased. The basic factors to be considered while fixing the ordering quantity are as follows: -

1. There should be no overstocking.
2. Materials should always be available in sufficient quantity to meet the requirements of production and to avoid plant shut down.
3. Purchases should be made in economic lots.

Other factors to be considered are quantity already ordered, availability of funds, business cycle... Etc.

Purchase department in manufacturing concerns is usually faced with the problem of deciding the quantity of various items, which they should purchase basing on the above factors. If purchases of material are made in bulk, then inventory cost will be high. On the other hand, if the order size is small each time then the ordering cost will be very high. In order to minimize ordering and carrying costs it is necessary to determine the order quantity which minimizes these two costs.

2.12 Economic Order Quantity: (EOQ)

The total costs of a material usually consist of Buying Cost + Total Ordering Cost + Total Carrying Cost.

Economic Order Quantity is ‘The size of the order for which both ordering and carrying cost are minimum’.

Ordering Cost:

The costs which are associated with the ordering of material. It includes cost of staff posted for ordering of goods, expenses incurred on transportation, inspection expenses of incoming material etc

Carrying Cost:

The costs for holding the inventories. It includes the cost of capital invested in inventories. Cost of storage, Insurance. Etc

The assumptions underlying the Economic Ordering Quantity (EOQ): The calculation of economic order of material to be purchased is subject to the following assumptions: -

1. Ordering cost per order and carrying cost per unit per annum are known and they are fixed.
2. Anticipated usage of material in units is known.
3. Cost per unit of the material is constant and is known as well.
4. The quantity of material ordered is received immediately i.e. lead time is Zero.

The famous mathematician ‘WILSON’ derived the formula used for determining the size of order for each purchases at minimum ordering and carrying costs, which is as below: -

Economic Ordering Quantity =

Where,

A = Annual demand /Consumption

O = Ordering Cost per order

C = Carrying Cost per unit per annum.

2.13 Material Storage & Control

Once the material is received, it is the responsibility of the stores-in-charge, to ensure that material movements in and out of stores are done only against the authorized documents. Stores-in-charge is responsible for proper utilization of storage space & exercise better control over the material in the stores to ensure that the material is well protected against all losses such as theft, pilferage, fire, misappropriation etc.

Duties of store keeper:

The duties of store-keeper are as follows: -

1. To exercise general control over all activities in stores department.
2. To ensure safe storage of the materials.
3. To maintain proper records.
4. To initiate purchase requisitions for the replacement of stock of all regular materials, whenever the stock level of any item in the store reaches the Minimum Level.
5. To initiate the action for stoppage of further purchasing when the stock level approaches the Maximum Level.
6. To issue materials only in required quantities against authorized requisition documents.
7. To check and receive purchased materials forwarded by the receiving department and to arrange for storage in appropriate places.

Different classes of stores: -

Broadly speaking, there are three classes of stores

1. Central Stores
2. Decentralized stores
3. Sub-Store (Imprest Store)

Centralized stores:

The usual practice in most of the concerns is to have a central store. Separate store to meet the requirements of each production department are not popular because of the heavy expenditure involved. In case of centralized stores materials are received by and issued from one stores department. All materials are kept at one central store. The advantages and disadvantages of this type of store are set out as follows:

Advantages of centralized stores:

1. Better control can be exercised over stores because all stores are housed in one department. The risk of obsolescence of stores can be minimized.
2. The economy of staff-experts, or clerical, floor space, records and stationery are available.
3. Better supervision is certainly possible.
4. Obsolescence of the stores items can be kept under strict vigil and control.
5. Centralized material handling system can be put into operation thus further economizing on space, personnel and equipments.
6. Investment in stocks can be minimized.

Disadvantages of centralized stores:

1. The transportation costs of the materials may increase because the movements of the stores may be for a greater distance since the storing is centralized.
2. If the user departments are far away from the stores there may be delay in receipt of the stores by those departments.
3. Breakdown of inter-departmental transport system may hold up the entire process, and similarly labour problem in the centralized stores may bring the entire concern to standstill.
4. There is greater chance of losses through fire, burglary or some other unhappy incidents.
5. It may not be safe to have some hazardous elements bunched together in the centralized stores.

Decentralized stores:

Under this type of stores, independent stores are situated in various departments. Handling of stores is undertaken by the store keeper in each department. The departments requiring stores can draw them from their respective stores situated in their departments. The disadvantages of centralized stores can be eliminated, if there are decentralized stores. But these types of stores are uncommon because of heavy expenditure involved.

Central stores with sub-stores:

In large organizations, factories / workshops may be located at different places which are far from the central stores. So in order to keep the transportation costs and handling charges to the minimum level, sub-stores should be situated near to the factory. For each item of materials, a quantity is determined and this should be kept in the stock at the beginning of any period. At the end of a period, the store keepers of each sub-store will requisition from the central stores the quantity of the materials consumed to bring the stock up to the predetermined quantity. In short this type of stores operates in a similar way to a petty cash system, so this system of stores is also known as the imprest system of stores control.

Advantages:

1. It ensures the prompt issue of stores.
2. It confines the advantages of centralized stores with sub-stores and at the same time it does not sacrifice the centralized control.
3. It reduces handling cost of materials.
4. It avoids the maintenance of elaborate inventory records.

2.14 Maximum Level, Minimum Level & Reorder Level

After the material classification and codification is done for all the materials, for each material code we have to fix the Minimum Level, Maximum Level, Re-order Level and Re-Order Quantity. It is the storekeeper’s responsibility to ensure inventory of any material is maintained between the Minimum Level and Maximum Level.

Maximum Level:

The Maximum Level indicates the maximum quantity of an item of material that can be held in stock at any time. The stock in hand is regulated in such a manner that normally it does not exceed this level. While fixing the level, the following factors are to be taken into consideration:

1. Maximum requirement of the store for production purpose, at any point of time.
2. Rate of consumption and lead time.
3. Nature and properties of the Store: For instance, the maximum level is necessarily kept low for materials that are liable to quick deterioration or obsolescence during storage.
4. Storage facilities that can be conveniently spared for the item without determinant to the requirements of other items of stores.
5. Cost of storage and insurance.
6. Economy in prices: For seasonal supplies purchased in bulk during the season, the maximum level is generally high.
7. Financial considerations: Availability of funds and the price of the stores are to be kept in view. For costly items, the maximum level should be as low as possible. Another point to be considered is the future market trend. If prices are likely to rise, the concern may like to stock-piling for keeping large stock in reserve for long-term future uses and in such a case, the level is pushed up.
8. Rules framed by the government for import or procurement. If due to these and other causes materials are difficult to obtain and supplies are irregular the maximum level should be high.
9. The maximum level is also dependent on the economic ordering quantity.

Maximum Level =   Re-Order Level + Re-Order Qty – (Minimum Rate of       Consumption X Minimum Re- Order Period)

Minimum Level:

The Minimum Level indicates the lowest quantitative balance of an item of material which must be maintained at all times so that there is no stoppage of production due to the material being not available. In fixing the minimum level, the following factors are to be considered:

1. Nature of the item: For special material purchased against customer’s specific orders, no minimum level is necessary. This applies to other levels also.
2. The minimum time (normal re-order period) required replenishing supply: This is known as the Lead Time and are defined as the anticipated time lag between the dates of issuing orders and the receipt of materials. Longer the lead time, lower is minimum level, the re-order point remaining constant.
3. Rate of consumption (normal, minimum or maximum) of the material.

Minimum Level  = Re-Order level – (Normal Rate of Consumption X Normal Re

Order Period)

Re-Order Level:

When the stock in hand reach the ordering or re-ordering level, store keeper has to initiate the action for replenish the material. This level is fixed somewhere between the maximum and minimum levels   in such a manner that the difference of quantity of the material between the Re-Ordering Level and Minimum Level will be sufficient to meet the requirements of production up to the time the fresh supply of material is received.

The basic factors which are taken into consideration in fixing a Re-Ordering Level for a store item include minimum quantity of item to be kept, rate of consumption and lead time which are applied for computing of this level.

Re-Ordering level= Minimum Level + Consumption during lead time

= Minimum Level + (Normal Rate of Consumption × Normal Re-Order Period)

Another formula for computing the Re-Order level is as below

Re-Order level = Maximum Rate of Consumption X Maximum Re-Order period (lead time)

Danger Level:

It is the level at which normal issue of raw materials are stopped and only emergency issues are only made. This is a level fixed usually below the Minimum Level. When the stock reaches this level very urgent action for purchases is indicated. This presupposed that the minimum level contains a cushion to cover such contingencies. The normal lead time cannot be afforded at this stage. It is necessary to resort to unorthodox hasty purchase procedure resulting in higher purchase cost.

The practice in some firms is to fix danger level below the Re-Ordering Level but above the Minimum Level. In such case, if action for purchase of an item was taken when the stock reached the Re-Ordering Level, the Danger Level is of no significance except that a check with the purchases department may be made as soon as the Danger Level is reached to ensure that everything is all right and that delivery will be made on the scheduled date.

Danger Level = Normal Rate of Consumption × Maximum Reorder Period for emergency purchases

2.15 Stores Records

The bin cards and the stores ledger are the two important stores records that are generally kept for making a record of various items.

Bin Card:

Bin Card is a quantitative record of receipts, issues and closing balance of items of stores. Separate bin cards are maintained for each item and are placed in shelves or bins. This card is debited with the quantity of stores received, credited with the quantity of stores issued and the balance of quantity of store is taken after every receipt or issue. The balance quantity of the item may be easily known at any time. To have an up to date balance of stores, the principle of ‘before touching the item, bin card should be touched’. For each item of stores, Material Code, Minimum Quantity, Maximum Quantity, Ordering Quantity, Balance Quantities are stated on the bin card. Bin card is also known as ‘Bintag’ or ‘Stock card’.

Stores Ledger:

Stores Ledger is maintained by the costing department to make record of all receipts, issues of materials with quantities, values (Sometimes unit rates also). Ledger resembles with bin cards except that receipts, issues and balances are shown along with their money value. The ledger contains an account for every item of stores in which receipts, issues and balances are recorded both in quantity and value.

Difference between Bin Card and Stores Ledger: -

Reconciliation of Stores ledger and Bin Card:

Normally there should not be any difference between the quantities shown in the Bin Card and the Stores Ledger. However, in practice differences arise mainly due to the following reasons: -

1. Arithmetical error in working out the balances.
2. Non-posting of a document either in a bin card or in the stores ledger may be due to non receipt of a document.
3. Posting in the wrong bin card or in the wrong sheet (code) of the stores ledger.
4. Posting of receipts under issue and vice-versa.
5. Materials issued or received on loan or for approval are sometimes entered in bin card, but not in stores ledger.

Any difference between the stores ledger and bin card defeats the purpose for which the two separate sets are maintained and renders physical stocking ineffective as the correct book balance for the purpose of comparison with physical balance is not available. So to control or reduce the mismatch between the stores ledger and bin card and maintain the correct balance in the books of accounts various methods are followed.

2.16 Perpetual Inventory System

Perpetual Inventory System may be defined as ‘a system of records maintained by the controlling department, which reflects the physical movements of stocks and their current balance’. Thus it is a system of ascertaining balance after every receipt and issue of materials through stock records to facilitate regular checking and to avoid closing down the firm for stock taking. To ensure the accuracy of the perpetual inventory records (bin card and Stores ledger), physical verification of stores is made by a programme of continuous stock taking.

The operation of the perpetual inventory system may be as follows: -

1. The stock records are maintained and up to date posting of transactions are made there in so that current balance may be known at any time.
2. Different sections of the stores are taken up by rotation for physical checking. Every day some items are checked so that every item may be checked for a number of times during the year.
3. Stores received but awaiting quality inspection are not mixed up with the regular stores at the time of physical verification, because entries relating to such stores have not yet been made in the stock records.
4. The physical stock available in the store, after counting, weighing, measuring or listing as the case may be, is properly recorded in the bin cards / Inventory tags and stock verification sheets.

Perpetual inventory system should not be confused with continuous stock taking; Continuous stock taking is an essential feature of perpetual inventory system. Perpetual inventory means the system of stock records and continuous stock taking, where as continuous stock taking means only the physical verification of the stock records with actual stocks.

In continuous stock taking, physical verification is spread throughout the year. Everyday 10 to 15 items are taken at random by rotation and checked so that the surprise element in stock verification may be maintained and each item may be checked for a number of times each year. On the other hand, the surprise element is missing in case of periodical checking, because checking is usually done at the end of year.

Advantages of perpetual inventory system:

1. The system obviates the need for the physical checking of all items of stock and stores at the end of the year.
2. It avoids the dislocation of the routine activities of the organisation including production and dispatch.
3. A reliable and detailed check on the stores is maintained.
4. Errors, irregularities and loss of stock through other methods are quickly detached and through necessary action recurrence of such things in future is minimized.
5. As the work is carried out systematically and without undue haste the figures are readily available.
6. Actual stock can be compared with the authorized maximum and minimum levels, thus keeping the stocks within the prescribed limits. The disadvantages of excess stocks are avoided and capitalized up in stores materials cannot exceed the budget.
7. The recorder level of various items of stores are readily available thus facilitating the work of procurement of stores.
8. For monthly or quarterly financial statements like Profit and Loss Account and Balance Sheet   the stock figures are readily available and it is not necessary to have physical verification of the balances.

2.17 Periodical Stock Verification

This system envisages physical stock verification at a fixed date/period during the year. Generally, under this system the activity takes place at the end of the accounting period or a date close to such date. Usually the system is opened in the following manner:

1. A period of 5/7 days, depending on the magnitude of the work is chosen during which all the items under stock are verified physically and such period is known as ‘cut-off’ period. During this period there are no movements of stock items and neither ‘receipts’ nor are ‘issues permitted.
2. The items are physically counted/measured depending on their nature and are noted down in records which are signed by the auditors if they are present in stock verification.
3. The bin cards balances are also checked and initiated. Generally, the physical balances and bin card balances of various items should be same unless shortage/excesses are there or the recording/ balancing in the cards are incorrect.
4. After the physical verification is completed work sheets are countersigned by the godown supervisors and the stock verified.
5. Thereafter reconciliation statement is prepared item wise where the physical balances and bin card balances are different.
6. Then the balance as per bin cards and as per stores ledger is also compared and necessary adjustments are made to show the correct position of stock at the year end.
7. Finally, the shortages/excess statement is prepared by the concerned department and is placed before the higher management for their approval for adjustments.

2.18 Inventory Turnover Ratio

Inventory Turnover signifies a ratio of the value of materials consumed during a given period to the average level of inventory held during that period. The ratio is worked out on the basis of the following formula:

Inventory Turnover Ratio = Value of material consumed during the period

Value of average stock held during the period

The purpose of the above ratio is to ascertain the speed of movement of a particular item. A high ratio indicates that the item is moving fast with a minimum investment involved at any point of time. On the other hand, a low ratio indicates the slow moving item. Thus Inventory Turnover Ratio may indicate slow moving dormant and obsolete stock highlighting the need for appropriate managerial actions.

2.19 Valuation of Material Receipts

Principles of valuation of receipt of materials as per CAS-6 (limited Revision 2017) are as follows: -

1. The material receipt should be valued at purchase price including duties and taxes, freight inwards, insurance and other expenditure directly attributable to procurement (net of trade discounts, rebates, taxes and duties refundable) that can be quantified with reasonable accuracy at the time of acquisition.
2. Finance costs incurred in connection with the acquisition of materials shall not form part of the material cost.
3. Self manufactured item shall be valued including the direct material, direct labour, direct expenses, factory overheads, share of administrative overheads relating to the production but excluding share of other administrative overheads, finance cost and marketing overheads. In case of captive consumption, valuation shall be in accordance with Cost Accounting Standard-4.
4. Spares which are specific to an item of equipment shall not be taken into inventory, but shall be capitalized with cost of specific equipment. Cost of Capital spares and / or insurance spares, whether procured with the equipment or subsequently, shall be amortized over a period, not exceeding the useful life of the equipment.
5. Normal loss or spoilage of material prior to reaching the factory or at places where the services are provided shall be absorbed in the cost of balance materials net of amounts recoverable from suppliers, insurers, carriers or recoveries from disposal.
6. Losses due to shrinkage or evaporation and gain due to elongation or absorption or moisture ...etc before the material is received is absorbed in material cost to the extent they are normal, with corresponding adjustment in quantity.
7. The foreign exchange component of imported material cost is converted at the rate on the date of transaction (material / service recording in books of accounts). Any subsequent change in the exchange rate till payment or otherwise shall not form part of the material cost.
8. Any demurrage or detention charges, or penalty levied by transport or other authorities shall not form part of the cost of materials.
9. Subsidy/grant/incentive and any such payment received / receivable with respect to any material shall be reduced from cost for ascertainment of the cost of the cost object to which such amounts are related.

2.20 Valuation of Material Issues

Principles of valuation of issue of materials as per CAS-6 (Limited Revision, 2017) are as follows: -

1. Issues shall be valued using appropriate assumptions on cost flow such as FIFO, LIFO, and Weighted average rate. The method of valuation shall be followed on a consistent basis.
2. Where materials are accounted at standard cost, the price variances related to materials shall be treated as part of material cost.
3. Any abnormal cost shall be excluded from the material cost.
4. Wherever the material cost includes the transportation costs, determination of transportation cost shall be based on CAS-5, i.e. Equalized Transportation Costs.
5. Material cost may include imputed costs not considered in Financial Accounts.
6. Self manufactured components and sub-assemblies item shall be valued including the direct material, direct labour, direct expenses, factory overheads, share of administrative overheads relating to the production but excluding share of other administrative overheads, finance cost and marketing overheads. In case of captive consumption, the valuation shall be in accordance with Cost Accounting Standard-4.
7. The material cost of normal scrap / defectives which are rejects shall be included in the material cost of goods manufactured. The material cost of actual scrap / defectives, not exceeding the normal shall be adjusted in the material cost of good production. Material cost of abnormal scrap/ defectives should not be included in material cost but treated as loss after giving credit to the realisable value of such scrap / defectives.

Materials issued from stores should be priced at the price at which they are carried in inventory. Material may be purchased from different suppliers at different prices in different situations, where as consumption may happen the entire inventory at a time or at different lots. Etc. So issue of materials should be valued after considering the following factors: -

1. Nature of business and production process.
2. Management policy relating to the closing stock valuation.
3. Frequency of purchases and price fluctuations.

Several methods of pricing of material issues have been evolved; these may be classified into the following: -

1. First in First out (FIFO)
2. Weighted Average Price Method

1. First in – First Out Method:

It is a method of pricing the issue of materials in the order in which they are purchased. In other words, the materials are issued in the order in which they arrive in the store. This method is considered suitable in times of falling price because the material cost charged to production will be high while the replacement cost of materials will be low. In case of rising prices this method is not suitable.

Advantages of FIFO:

1. It is simple and easy to operate.
2. In case of falling prices, this method gives better results.
3. Closing stocks represents the market prices.

Disadvantages:

1. If the prices fluctuate frequently, this method may lead to clerical errors.
2. In case of rising prices this method is not advisable.
3. The material costs charged to same job are likely to show different rates.

2.     Weighted Average Price Method:

This method removes the limitation of Simple Average Method in that it also takes into account the quantities which are used as weights in order to find the issue price. This method uses total cost of material available for issue divided by the quantity available for issue.

Issue Price = Total Cost of Materials in stock / Total Quantity of Materials in stock