UNIT 2: Material and Labour Costing (Pages 3 & 4)
Page 3: Material Costing and Inventory Control
2.1. Material Costing
Direct Material Cost: Costs that can be easily identified and quantitatively
measured with the final product (e.g., leather in shoes).
Indirect Material Cost: Materials that cannot be easily traced to the product
or are too insignificant (e.g., nails, lubricants). These are part of overheads.
2.2. Material Purchase Procedure
1. Indenting: Production department raises a Purchase Requisition based on
material requirements.
2. Enquiry: Purchase department sends enquiries to registered suppliers for
quotations.
3. Order Placement: Placing a Purchase Order with the selected supplier after
comparing bids (considering price, quality, terms).
4. Receipt & Inspection: Materials received and checked by the Receiving
Department, then inspected by the Quality Department.
5. Storage: Materials stored in the Stores Department, recorded in a Bin Card
and Stores Ledger.
2.3. Inventory Control: Stock Levels
Maximum Level: The highest stock quantity to be held at any time.
$$\text{Max Level} = \text{Re-Order Level} + \text{Re-Order Quantity} - (\
text{Minimum Consumption} \times \text{Min Re-Order Period})$$
Minimum Level (Safety Stock): The lowest stock quantity that must be
maintained to prevent production stoppages.
$$\text{Min Level} = \text{Re-Order Level} - (\text{Average Consumption} \
times \text{Average Re-Order Period})$$
Re-Order Level (Ordering Point): The level at which the purchase requisition
should be initiated.
$$\text{R.O.L.} = \text{Maximum Consumption} \times \text{Maximum Re-
Order Period}$$
Danger Level: A level below the minimum stock where urgent action is
required to procure materials.
2.4. Economic Order Quantity (EOQ)
Concept: The optimum size of the order for materials that minimizes the total
cost of ordering and carrying inventory.
Costs Considered:
o Ordering Cost: Cost of placing and receiving an order (e.g.,
administrative cost, transportation).
o Carrying Cost: Cost of holding inventory (e.g., storage, insurance,
obsolescence, interest on capital).
$$EOQ = \sqrt{\frac{2 \times \text{Annual Usage} \times \text{Ordering Cost
per Order}}{\text{Carrying Cost per Unit per Annum}}}$$
Page 4: Issue of Materials and Labour Costing
2.5. Issue of Materials to Production & Pricing Methods (Theory)
The Stores Ledger records the receipt and issue of materials to production.
Issues are valued using specific methods:
FIFO (First-In, First-Out):
o Concept: Materials received first are issued first.
o Effect: Stock valuation is close to the current market price. Cost of
issues is based on older, potentially lower prices.
LIFO (Last-In, First-Out):
o Concept: Materials received last are issued first.
o Effect: Cost of issues is close to the current market price (relevant
during inflation). Stock valuation is based on older, potentially historical
prices.
Simple Average:
o Concept: Issue price is calculated by dividing the total of unit prices by
the number of prices. Ignores the quantities purchased at each price.
Weighted Average:
o Concept: Issue price is calculated by dividing the total cost of
materials by the total quantity of materials available. Considers the
quantity purchased at each price, making it more accurate.
2.6. Labour Costing
Direct Labour Cost: The cost of labour directly involved in manufacturing the
product (part of prime cost).
Indirect Labour Cost: Wages paid for auxiliary functions that do not alter the
material (e.g., security, factory manager's salary). These are part of
overheads.
2.7. Methods of Wage Payment
Time Wage System: Wages are paid based on the time spent working,
regardless of the output.
o Advantage: Guaranteed minimum wages; simple calculation.
o Disadvantage: No incentive for efficiency; workers may become slow.
Piece Wage System: Wages are paid based on the number of units
produced or jobs completed.
o Advantage: Strong incentive for high productivity; rewards efficiency.
o Disadvantage: Quality may suffer; minimum wages not guaranteed.
2.8. Incentive Schemes (Premium Bonus Plans)
Halsey Plan: Worker is guaranteed time wages. Bonus is paid as a
percentage (usually 50%) of the time saved.
$$\text{Total Earnings} = (\text{Time Taken} \times \text{Rate per Hour}) +
50\% \times (\text{Time Saved} \times \text{Rate per Hour})$$
Rowan Plan: Worker is guaranteed time wages. Bonus is calculated as a
proportion of the time wages as the ratio of time saved bears to the standard
time.
$$\text{Total Earnings} = (\text{Time Taken} \times \text{Rate per Hour}) + \
frac{\text{Time Saved}}{\text{Standard Time}} \times (\text{Time Taken} \times
\text{Rate per Hour})$$
Taylor’s Differential Piece Rate System: A non-guaranteed scheme.
Rewards efficient workers highly and penalizes inefficient workers severely by
using two piece rates: a higher rate for production at or above standard, and a
lower rate for production below standard