Material Costing Flashcards
(34 cards)
Material Cost
Material Cost is the cost of all raw materials and components used in the production of a product or service.
➕ It includes:
Purchase price (net of discounts)
Transportation costs
Insurance and taxes
Unloading and storage (if specifically attributable)
Types of Materials
Direct Materials Can be directly traced to the product Wood in furniture, steel in cars
Indirect Materials Not directly identifiable in finished product Lubricants, cleaning supplies
Purchase Procedure
Purchase Requisition from stores or production
- Supplier Selection and Purchase Order
- Receiving and Inspection
- GRN (Goods Received Note)
- Invoice Verification and Payment
Inventory Control Techniques
(A) ABC Analysis
> Categorize items by value:
A – High value, low quantity
B – Moderate value and use
C – Low value, high quantity
📌 Used for control and resource allocation.
🔸 (B) EOQ (Economic Order Quantity)
> Determines the optimal quantity to order that minimizes total ordering and carrying costs.
🔹 Formula:
EOQ = \sqrt{\frac{2AB}{C}}
Where:
A = Annual usage (units)
B = Ordering cost per order
C = Carrying cost per unit per year
🔸 (C) Reorder Level
> Level of stock at which new order should be placed.
\text{Reorder Level} = \text{Maximum usage} \times \text{Maximum lead time}
🔸 (D) Minimum Level
> Stock should not fall below this.
\text{Minimum Level} = \text{Reorder level} - (\text{Normal usage} \times \text{Normal lead time})
🔸 (E) Maximum Level
\text{Maximum Level} = \text{Reorder level} + \text{Reorder quantity} - (\text{Minimum usage} \times \text{Minimum lead time})
Issue Pricing Methods
FIFO First-in-first-out. Material used from earliest lot. Best when prices are rising (low COGS)
LIFO Last-in-first-out. Latest material issued first. Best when prices are falling
Weighted Average Average cost = Total cost ÷ Total units Smoothens out price fluctuations
Simple Average Avg of prices, not based on quantities Easier but less accurate
Standard Price Pre-decided price for budgeting and control Used in variance analysis
Wastage and Losses
Normal Loss Expected, unavoidable loss (e.g., evaporation)
Abnormal Loss Avoidable or unexpected loss (e.g., theft)
Scrap Residual material of little or no value
Spoilage Material damaged beyond repair
Defective Can be reworked with extra cost
What is the difference between direct and indirect materials?
Accurate product costing
Efficient material control
Minimizing wastage
Pricing and decision-making
Budgeting and variance analysis
What are the steps in the material procurement process?
- Purchase Requisition
- Quotation & Supplier Selection
- Purchase Order
- Goods Receipt & Inspection
- GRN & Invoice Matching
- Material Storage
What is EOQ and how is it calculated?
EOQ (Economic Order Quantity) is the optimal order size that minimizes ordering + carrying cost.
EOQ = \sqrt{\frac{2AB}{C}}
✅ Logic: If you order too often → high ordering cost. If you order large quantity → high storage cost. EOQ balances both.
Explain Reorder Level, Minimum Level & Maximum Level.
Answer:
Reorder Level = Max Usage × Max Lead Time
Minimum Level = Reorder Level − (Normal Usage × Normal Lead Time)
Maximum Level = Reorder Level + Reorder Qty − (Min Usage × Min Lead Time)
✅ Purpose: To avoid both stock-out and overstocking.
What are the different inventory valuation methods? Which is best?
FIFO (First In First Out)
LIFO (Last In First Out)
Weighted Average
Simple Average
Standard Price
✅ FIFO suits inflation — older, cheaper stock gets issued first, hence lower cost of goods sold.
✅ Weighted Average smoothens price fluctuations.
✅ Standard Price helps in variance analysis.
What is ABC Analysis in material management?
It’s a control technique based on value of inventory:
A: High value, tight control
B: Medium value, moderate control
C: Low value, simple control
🔍 10% items may account for 70% value.
What are normal and abnormal losses?
Normal Loss: Unavoidable (e.g., evaporation)
Abnormal Loss: Due to negligence or accident (e.g., spillage, theft)
✅ Normal loss is absorbed into the cost. Abnormal is charged to Costing P&L.
How are material returns treated in costing?
If returned to supplier → Purchase return
If returned from production → Debited to store ledger at issue price
If scrapped → Scrap value deducted from material cost
FIFO vs Weighted Average – which is better during inflation?
During inflation:
FIFO: Issues old, cheap materials → Lower COGS → Higher profit
Weighted Avg: Smooths price → More stable, fairer cost reporting
✅ For internal decision-making → Weighted Average is more logical.
✅ For tax saving → LIFO (not allowed in India now) would have worked better.
What challenges arise in real-world material pricing?
Price volatility
Delayed GRN entry leads to wrong pricing
Material mix and quality differences
Difficulty in tracing indirect costs
How does material wastage affect costing and profitability?
Increases unit cost if not controlled
If abnormal → hits profit directly
Can distort product pricing and mislead decision-making
✅ Best practice: Implement control points at every stage — inspection, SOPs, and variance analysis.
How would you value material inventory if prices fluctuate daily?
Use Weighted Average Method or Standard Costing
Maintain Material Price Index
Daily updating is needed in ERP systems to ensure accuracy.
How does incorrect material cost affect pricing decisions?
Understated cost → Lower price → Losses
Overstated cost → Higher price → Market uncompetitiveness
✅ Pricing decisions must be based on realistic costing and market trend analysis.
Why is it important to include freight, insurance, and taxes in material cost?
Because they are directly attributable to bringing the material to its present location and condition for use. Ignoring these would understate the cost and lead to underpricing of the product.
📌 Cost Accounting Standard (CAS-6) mandates inclusion of all such directly attributable costs.
Why can’t we use market price for issuing material instead of FIFO/LIFO/Avg?
Market prices fluctuate and are not verifiable or auditable. FIFO, LIFO, and Weighted Avg. offer systematic, consistent, and accountable methods, necessary for both internal control and statutory compliance.
What are the limitations of the FIFO method?
Complex record-keeping if there are frequent purchases.
Cost of goods issued may be outdated — doesn’t reflect current market prices.
Profits may appear inflated during inflationary periods, causing tax disadvantages.
Why is LIFO not permitted in India under Ind AS?
LIFO can distort profits in inflationary periods (by reporting lower profits), and is considered less reflective of current cost. It also doesn’t provide comparability between firms, which violates true and fair view of financials.
What is the impact of choosing a material pricing method on financial reporting?
Affects Cost of Goods Sold (COGS)
Impacts inventory valuation on Balance Sheet
Changes profit margins
Influences tax liability
Thus, consistency in method is crucial unless changed with valid reasoning and disclosure.
