Material Cost Classification

Materials refer to the tangible inputs into the process of producing useful output. They could be direct materials or indirect materials (overheads) e.g. to produce tea, tealeaves is the material (input).

Material cost classification

Material costs may be classified as:

  1. Direct Material Cost: Refers to costs of materials that may readily be identified with output units. The cost of timber used in the manufacture of a chair is an example of a direct material.
  2. Indirect Material cost: refers to items of raw materials for which it would be difficult and or inefficient to attempt to charge directly to specific cost units. For example the glue used to bind the joints in the assembly of a chair

Other examples of indirect materials include:

  • Materials used by service departments e.g. spare parts used by maintenance department in repairing and servicing plant and machinery
  • Materials used by non production functions e.g. stationary used in accounting department

Material cost control

Materials form a significant cost of output units and therefore should be controlled. Material Control is more than simply recording the accounting transactions relating to material cost. Control should be implemented to ensure that material is available

  1. In appropriate quantities
  2. In appropriate quality
  3. In appropriate location
  4. At an appropriate time
  5. At the most economic cost

Control may be exercised at a number of points in the business cycle as follows

  1. When the choice is made as to the type and quality of material to be used
  2. Where the purchase order is being placed with the chosen supplier
  3. On receipt of the material from supplier, check the appropriateness of quality and quantity of materials received.
  4. Where the material is held in store before use: It must be safe from theft and damage
  5. Where the material is issued from the store: It must be issued to the correct department
  6. Where the material is being used for intended purposes e.g. the material must be utilized to produce the desired output.

The material control system must attempt to ensure that the company does not incur costs in excess of an agreed efficient level of expenditure. Lack of adequate control routines will result in the incidence of costs in excess of an acceptable level, reduced profitability of production and increased operational costs.

Inventory Control and Management

The objectives of inventory management are

  • To ensure adequate stocks to allow for continuous operations/production, and
  • To minimize the cost of having inventory.

Inventory management is important since in most organizations it represents the largest single investment. The major types of inventory are:

  • Raw materials
  • Work in progress
  • Finished goods

To achieve the above objectives of material cost costing , the manger has to make decisions regarding the following:

    1. What commodities to stock?
      • Use Material Requirement Planning

From the Master Production Schedule, the manager has determined the products to be produced. A Bill of Materials can then be prepared. This lists in descending order the components required to make the final product. The information required includes part name or description, part number, next higher level assembly, required quality per end item, quantity per end item and quantity required for the next higher level assembly.

Stores Ledger Account is also used to obtain information on what is currently available. The file shows balance on hand as well as past data on how much is usually ordered, lead-time, and safety stock.

From the above the manager can determine what need to be purchased.

    1. How much to stock?
  • Use The Economic Order Quantity Model

This is a simple model that helps the manager to determine the optimum quantity of stock to order so as to keep total costs at a minimum. The main costs of inventory are:

    • Holding or carrying costs
    • Ordering or set up costs
    • Shortage costs
  • Use Pareto Analysis

Items are classified into three classes as follows:

Class A: Theseare high cost, fast moving and high usage items. They are few accounting for only 20 percent of the total number of items yet account for 80 percent of the total inventory budget.

Class B: These are medium moving goods. They account for 15 percent of the total number of the budget

Class C: These are slow moving low value items. They are very many accounting for 65 percent of the total number of items and only 5 percent of the total inventory budget.

               When to stock?

This will be influence by the inventory system in place as follows:

  • Periodic order system.

The firm receives a new order of the amount specified by the order quantity at equal intervals of time. The firm determines the maximum and minimum inventory, the safety stock and the reorder level.

  • Continuous Review System

The firm places orders at regular intervals but the order quantity varies according to how much a firm requires to bring the level to some predetermined size or value.

  • Just In Time Inventory System

This is a concept developed by the Japanese and advocates zero inventory and stockless production. In addition, it calls for 100 per cent quality. Some of the major features of JIT include:

  1. Frequent and reliable deliveries to avoid inventory build up. Companies are also setting delivery dates with penalties for not meeting them.
  2. Closer location to suppliers and customers
  3. Improved communication between companies and suppliers through the use of computerized purchasing systems that allows for online ordering.
  4. Single sourcing and building long-term relations with a few trusted suppliers.
  1. Increased supplier involvement in the design aspects of a product to ensure that they meet the company’s quality requirements.
  2. Maintenance of strict quality control by all parties.

Material Handling

The objective is to ensure that goods are delivered to the right places at the right time and in aright manner to avoid delays, congestation and unnecessary handling. A big percentage of production costs is taken up by material handling activities. A good material handling system should minimize these costs.

The manger needs to determine the type of equipment to be used to handle the material. The type of equipment that is most frequently used includes:

  • Cranes
  • Lifts
  • Trucks
  • Conveyors
  • Towing

The factors that influence the type of equipment used includes:

  • Type of materials being moved
  • Volume
  • Rate or frequency of movement
  • Route of movement speed required
  • Method of storage employed
  • Safety or hazards involved.

Storage and Issue of Material

A number of factors are relevant in control of materials during storage and issue of materials. They are:

  1. Stores location and layout
  2. Stock level and its control.
  3. Stock control records and issue procedures
  4. Stock taking procedures
  5. Valuation of inventories (issues and closing stock)

Stores location and layout

The layout of stores should ensure

  1. Ease of access for movement of material in and out of stores
  2. The issue of perishable materials on a first in first out basis
  3. The segregation of toxic and dangerous materials in a separate location
  4. Security of materials by restriction of access to authorized personnel only

The location of stores should ensure

  1. Nearness to point of use to minimize expenditure on handling costs
  2. Specialist stores e.g. spare parts for machinery should be located close to the point of use.