Issue of materials and its valuation

1. Issue of materials and its valuation

2. CONTENTS • INTRODUCTION • MATERIAL REQUISITION • BILL OF MATERIAL • ADVANTAGES • POINT OF DIFFERENCE • SURPLUS OF MATERIAL • METHODS OF PRICING • FIFO • LIFO • HIFO • SPECIFIC PRICE • BASE STOCK

3. INTRODUCTION • Materials are kept in stores so that the storekeeper may issue them whenever the production department require these. A storekeeper cannot issue materials unless a proper authorisation is presented to him. Normally, materials are issued by a storekeeper on the basis of written request by the production department. The following two documents are used for issue of materials to production department: • MATERIAL REQUISITION • BILL OF MATERIALS

4. MATERIAL REQUISITION • A material requisition is an important document of an authority to the storekeeper to issue the materials. It is a formal written request from production department to store. It is signed by the authorized person, so that there may be no wrong drawl of materials. It includes date, requisition number, description, quantity, unit price, total value etc.

5. MATERIAL REQUISITION • The materials requisition form has two main purposes. First, it’s used to record the movement of materials throughout the manufacturing process. When the company orders goods, they are delivered to the storage facility and the appropriate forms are filled out. This gives an audit trail that show when goods were purchased and when they were delivered. When the production floor needs more materials, it requests them from storage with the materials requisition form. • This, again, adds a paper trail to show when the goods were moved from storage to manufacturing. These documents can also help managers determine when to order more materials. For example, if they see that goods are sitting in storage for months before making it into production, they will probably stop ordering those materials so often.

6. CONTD. • Second, the requisition form is used to allocate production costs to goods in process. Not all inventories in process will be finished in the current year. In other words, there will always be some goods in the production process. The requisition forms can help allocate costs and values to these materials.

9. BILL OF MATERIAL • Bill of material is the list of standard quantities of all material required for particular job or work order or a process. • WHO PREPARES IT? Bill of materials is prepared by engineering or planning department in a standard form on receipt of an order. • NO. OF COPIES? Usually four copies of bill materials are prepared- one copy of production department, one copy of stock department, one copy for cost accounting department and one copy is retained by engineering or planning department.

10. ADVANTAGES • It guides the purchase officer to purchase desire quantity and quality of material. • Helpful to cost accounting department. • It scores the purpose of an authority for the production department to place requisition for material stated in it. • Proper control and use of material is ensured. • It helps in planning and procuring material in advance.

12. POINT OF DIFFERENCE • The basic difference between material requisition and bill of material is that material requisition is prepared when a single or a few items of material are requisitioned whereas bill of material is prepared when all the materials required for a particular job are requisitioned.

13. TREATMENT OF SURPLUS MATERIAL

14. RETURN OF MATERIAL • Sometimes materials issued to a particular job are not consumed fully or drawn in excess of requirements, the excess of quantity is returned to the stores department.

16. TRANSFER OF MATERIAL • In certain cases it is necessary when an urgent job is to be completed and it is necessary to appropriate the excess material in order to avoid the delay. All such transfers of material must be accompanied by material transfer note which is signed by foreman of sending and receiving department.

18. METHODS OF PRICING ISSUE OF MATERIAL • The various methods used for pricing of material can be : ACTUAL COST METHOD a.) FIFO b.) LIFO c.) SPECIFIC PRICE d.) HIFO e.) BASE STOCK METHOD

19. FIFO • First-In, First-Out (FIFO) is one of the methods commonly used to calculate the value of inventory on hand at the end of an accounting period and the cost of goods sold during the period. This method assumes that inventory purchased or manufactured first is sold first and newer inventory remains unsold. Thus cost of older inventory is assigned to cost of goods sold and that of newer inventory is assigned to ending inventory.

20. Example Use the following information to calculate the value of inventory on hand on Mar 31 and cost of goods sold during March in FIFO.

22. LIFO • Last-In, First-Out is one of the common techniques used in the valuation of inventory on hand at the end of a period and the cost of goods sold during the period. LIFO assumes that goods which made their way to inventory (after purchase, manufacture etc.) later are sold first and those which are manufactured or acquired early are sold last. Thus LIFO assigns the cost of newer inventory to cost of goods sold and cost of older inventory to ending inventory account.

23. Example Use LIFO on the following information to calculate the value of ending inventory and the cost of goods sold of March. `

25. SPECIFIC PRICE METHOD • Under this method materials issued to production are priced at their purchase price. Here we make one important assumption that materials in the stores are capable of being identified as belonging to specific lots. Identification can be made by putting a price tag on each. It is a simple method and does not create accounting complication associated with working of fifo and lifo. Examples of situations in which the specific identification method would be applicable are a purveyor of fine watches or an art gallery.

26. HIFO • 'Highest In, First Out - HIFO' In accounting, it is an inventory distribution method in which the inventory with the highest cost of purchase is the first to be used or taken out of stock.

27. Example Use the following information to calculate the value of inventory on hand on Mar 31 and cost of goods sold during March in HIFO.

29. BASE STOCK METHOD • An accounting method of valuing inventories by carrying on the books a minimum quantity of a commodity at the same low fixed price from year to year and valuing the quantity in excess of the minimum at a separate price which is usually the lower of cost or market value — compare last in, first out. • It involves less clerical work in valuing the closing inventory because value of stock is fixed.

30. CONTENTS • AVERAGE COST METHODS • Weighted average method • Simple average price method • Periodic simple average method • Periodic weighted average method • Moving simple average method • Moving weighted average method • NOTIONAL PRICE METHODS • Standard price method • Inflated price method

31. Average cost method Under the 'Average Cost Method‘ it is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period. The average cost is computed by dividing the total cost of goods available for sale by the total units available for sale. This gives a weighted-average unit cost that is applied to the units in the ending inventory

32. Average Cost Methods

33. Weighted average method In this method the total cost of all the materials is divided by the total number of items in stock. The price calculated in this way will be used for price issue of materials upto the time a fresh purchase has not been made. After a fresh purchase, the quantity will be added to the earlier cost. A fresh purchase is calculated by dividing the total cost by the number of units in stock after the purchase.

36. Advantages • It is simple to understand and easy to operate. • It is logical and consistent. • When prices fluctuates, it will smooth out fluctuations. • Cost comparisons are rendered easier.

37. Disadvantages • Closing stock may not represent current market prices. • Materials cost does not represent the current prices. • Fresh calculations will have to be made every time a new purchase are made. This will mean much of arithmetical work and is likely to cause error. • This method requires tedious calculations.

38. 2. Simple average price method Under this method the following procedure is followed:- • When materials are purchased or received, same treatment is made we make in weighted average cost method. • At the time of issue of material, list of all purchases made till date is prepared and average of per unit prices are taken for issue price. Further issue is made in similar way keeping in mind the fact that those purchases, which were exhausted in earlier issues, are not considered for calculating the average price.

40. Advantages • This method is useful when prices are stable. • It is simple to operate. Disadvantages • Valuation of stock in hand is usually incorrect under this method. • There are chances of showing inaccurate profit or loss due to under charging and overcharging of material. • It does not project accurate total cost because it does not recover actual cost of materials from production.

41. 3. Periodic simple average method Under this method, all issues are made on a price which is calculated by taking the average of all the purchases made in a particular period. Since issue price is same for all issues, it is calculated at the end of the period (month). Periodic simple average issue price :-

44. ADVANTAGES • Easy to understand and simple to operate. • No need of different issue prices, so calculations are easy. • It is more suitable than simple average method particularly when production is continuous and carried over a longer period of time.

45. DISADVANTAGES • Issue price can not be determined unless all purchases in a period are made. Thus , this leads to accounting problems. • The value of stock do not represent the current market price or actual cost of the product. • Although better than simple average, this method is also unscientific.

46. 4. PERIODIC WEIGHTED AVERAGE METHOD Periodic weighted average price is calculated by dividing the total cost of materials purchased by the total quantity of material purchased. It is also calculated at the end. Periodic weighted average price =

50. 5. MOVING SIMPLE AVERAGE METHOD A moving average price is the price obtained by dividing the total of the average price of a number of periods by the number of periods, the last of the periods being that for which materials are valued. Under the simple moving average method, the first step is to choose specified purchases say 3 purchases or 4 purchases. Now suppose we select three purchases, average of three purchases made are calculated and any issue in between these three purchases is made on that price. After next purchases, first purchase price is left out and average of next three purchases are made and then issues accordingly.