Material, Labor,Ohd

8/8/2019 Material, Labor,Ohd

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MATERIAL COSTLABOR COST

andOVERHEADS


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The term material refers to all commodities consumed in theprocess of manufacturing.

Classification of Material

Direct Material is which can be conveniently identified with andallocated to cost unit.

Eg cotton used for textile; leatherfor shoes etc

Indirect Material is which cannot be conveniently identified withandallocated to cost unit.

E.g coal ; oil andgrease ; screws ; nuts etc


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Direct material cost includes:

Cost of procurement

Freight inwards

Taxes & duties

Insurance

Discounts,rebates etcare deductedin

determining the cost ofdirect material.


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Objective of Material Control

Avoid Under-stocking

Avoid Over-stocking

Minimize total cost

Minimize Wastage and losses

Economy in purchasing

Proper quality of material

Informationabout materials

Material report to management


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Principle of Inventory Control

** Properco-ordination betweenvarious departments

dealing in materials : purchase deptt ; stores deptt ;

receiving andinspectiondeptt ; productiondeptt;accounting deptt

** Central purchasing deptt

** Properclassificationandcodification

** Adequate safeguards and supervision

** Up-to date information ofinventory stocks


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Techniques of Inventory ControlI ABC Technique

This is a value-based system ofmaterial control. Valuablematerial are givengreater attention and care than less costly ones.

Category % of Total Value % of Total

Quantity

Type of

Control

A 70 10 strict control

B 25 30 moderate

control

C 5 60 less control

Total 100 100


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II Minimum, Maximum and Re-order level

Minimum Level is the level below which stock shouldnot normally be allowed to fall.

Incase it falls below this level then , there is adanger

of stoppage in production andtop priority shouldbe givento the purchase of new materials.

Objective : avoid the cost of

under-stocking loss due to stoppage ;

idle labor cost ;

idle P&M


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Minimum Level

= Re-order level (normal consumption x normalre-order period)

Factors to be considered : normal rate of consumption ofmaterial time required to obtain the delivery of the newmaterials

re-order level


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Maximum level is the level above which stocksshould not normally be allowed to rise.

Objective: avoid the cost of over stocking storage cost ;

investment in stock ; insurance cost ; risk of obsolescence

Maxi Level= Re-order level + Re-order quantity

( minimum consumption x minimum re-order

period )


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Factors to be considered :

Minimum rate of consumption of the material

Storage space available

Risk of obsolescence and deterioration

Cost of storage

Insurance cost

Re-order quantity Bulk purchases of seasonal materials


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Re-order level is the level at which a new order for

material is placed .It is at this level that purchase requisition is madeout.

Note: This level is above the minimum level andbelow the maximum level.

Objective: determine when the fresh order shouldbe placed


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Re-order Level =

Maximum consumption x Maximum re-orderperiod

Factors to be considered :

maximum rate of consumption ofmaterial

time required to obtain the delivery of the new

materials i.e. lead time minimum level


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Illustration :A company uses three raw materials A,B and C for the manufacturing ofa

particular product. The following datais available:

RawMater-

ial

Usageper Unit

of

Product

(kgs)

Re-Order

Quantit

y

(kgs)

Priceper

kg

Delivery Period (in weeks) Re-Order

Level

(kgs)

Minimum level

(kgs)

Minimu

m

Average Maxim

um

A 10 10,000 0.10 1 2 3 8,000

B 4 5,000 0.30 3 4 5 4,750

C 6 10,000 0.15 2 3 4 2,000


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Weekly productionvaries from 175 to 225 units ,

averaging 200 units of the said product.

What would be the :

(a) Minimum stock of A

(b) Maximum stock of B

(c) Re-order level of C


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Solution:

a) Minimum stock of A

=Re-order Level ( Normal rate of consumption* Normal time required to obtain fresh delivery)

= 8,000 [ ( 10 * 200)* 2] = 4,000 kg


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b) Maximum stock of B

=re-order level + re-order quantity ( mini .

consumption x mini re-order period)

= 4,750+ 5,000 [ (4*175)*3] = 7,650 kg

c) Re-order level of C

= Maximum Consumption x Maxi. Re-orderperiod

= (6 * 225)* 4 = 5,400 kg


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III Economic Order QuantityEOQ is the quantity to be ordered whenevermaterials are to be purchased .This is the size which gives the maximum economyin purchasing any material andultimately contributes towards maintaining thematerial at the optimum level and at the minimumcost.Assumptions :

Prior knowledge of annual usage of inventory Constant rate of usage Constant ordering cost Constant carrying cost

Zero lead time


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EOQ = 2AO/ CS

EOQ: economic order quantity

A: annual consumption of inputs (in units)

O: ordering cost per order

C: cost per unit ofmaterial

S: storage and carrying cost % of cost


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Number of Orders per year

=Total Annual Consumption (in units) / EOQ

Economic Order Frequency

=365 days / Number of orders per year

Total Annual Ordering and Carrying Cost at EOQ

= 2 AOC


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Ordering Cost refers to the costs incurred foracquiring inputs . It includes:

the cost of placing the order ( preparing thepurchase order, cost of stationery ),

cost of transportation , salaries of those engaged in receiving and

inspecting, etc.

Relationship between order size and ordering cost Larger the order size : lower the ordering cost

(less orders) Smaller the order size: higher the ordering cost (

more orders)


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Cost of Storage or Cost of Carrying refers to the costsincurred in maintaining a given level of inventory. It

includes : Cost of storage space

Cost of storage staff

cost of handling material

interest on capital locked in stores , insurance cost ,

risk of obsolescence and deterioration,

wastage etc.

Relation ship with order size: Larger the order size: higher the carrying cost (high

average inventory)

Smaller the order size : lower carrying cost (low average

inventory)


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Illustration :

Calculate the EOQ as well as the number of orders to

be placedin the quarter of the year .If

quarterly consumption of materials 2,000 kgcost of placing an order Rs 50/-

cost per unit Rs 40/-

storage andcarrying cost 8% ofaverage inventory

what will be the :

a) EOQ

b) Number of orders per quarter


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Solution:

EOQ = 2AO/ CS

= 2 * 8,000 * 50 / 40 *8%

= 500 kg

Number of Orders per Quarter

=Quarterly Consumption / EOQ

= 2,000 / 500

= 4 orders


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METHODS OF PRICING MATERIAL ISSUES

I First In First Out MethodThe material that is purchased first is issued first.

Merit :

simple to operate and easy to understand method

based on realistic assumption closing stock valued at the latest market price

does not result in un-realized profit/loss

Demerit:

in times of rising prices , charge to productionis unduly low in periods of rising prices , this method produces higher profits

and results inhigher tax liability as low cost is charged toproduction . Conversely in periods of falling prices , this method

produces lower profits and results in lower taxes .


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II Last In First Out Method

The material that is purchased last is issued first.

Merit:

the value of material is closely related to current

market price

in periods of rising prices , the profits and tax liability

under LIFO would be lower than under FIFO .Conversely in periods of falling prices , the closing

stock would be valuedat higher price and thus

profits and taxes wouldalso be higher.


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III Simple Average Price

This is calculated by adding all the different prices

anddividing by the number of such prices.

It does not take into account quantities of materials

while computing average price.

Merit :

simple methodDemerit :

unscientific

unrealized profit /loss may arise


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IV Weighted Average Price

Weightedaverage price per unit

= p1q1 + p2q2 + p3q3 / q1+q2+q3

Merit :

evens out the effect of widely varying prices of

different prices

scientific method

Demerit : requires gooddeal ofcalculations


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V Replacement Price

This is the price at which materials issued will bereplaced i.e. market price.Merit :

material issuedat current market price

no calculations requiredDemerit: issues are not pricedat actual cost , thusresulting in unrealized profit or loss.

VI Standard PriceThis is the pre-determined price andall materialissuedare valuedat this.

This is anotional price andnot actual cost price .


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LABOR COST

This represents the human contribution toproduction andit is the second major element of thecost after material.

In spite of the large-scale use of machines inmanufacturing of products , the role of laborin

productioncannot be under-estimated .

There is, therefore aneed for proper organization ,

accounting andcontrol of laborcost.


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Classification

Direct Laboris the cost of that labor who is directlyengaged in production work andconveniently identified orattributed wholly orpartly to a particular job , process orcost unit. E.g. :

wages ofmachines operators ,

weaver in weaving unit ,

carpenter in furniture unit

finisher etc

treatment : forms a part of the prime cost

variability : varies directly with the volume of output


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Indirect Laboris the cost of labor, who is not directlyengaged in converting raw material into finished products

andsuch cost cannot be conveniently identified with aparticular job , process or cost unit. E.g. job supervisors, product designer, product inspector, storekeeper, clerks , peons , watchmen, etc

treatment : forms a part of the overheadsvariability : may ormay not vary directly with the volume

of output


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Wages of workers include the fringe benefits like:

provident fund contribution, gratuity,

overtime ,

incentives, bonus,

leave encashment etc

for the purpose ofcalculation ofdirect laborcost.


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ORGANIZATION for ACCOUNTING and CONTROL of LABORCOST

Personnel Department : proper selection

training of the workers and

placing them to the jobs for which they are suited.

Engineering Department :

prepares plans andspecification of the jobs ,

makejob analysis, conduct time andmotion studies ,

make provision forsafe working conditions and

supervises productionactivity.


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Time- keeping Department :

recording of time put in by the workers forattendance , wage calculation ,

cost analysis and

apportionment of labor cost.

Payroll Department:

maintains a record of job classificationand wage rate for eachemployee and

performs the computation of wages payable anddisbursement of the same.


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Cost Accounting Department:

accumulates and classifies all cost data of which laboris oneelement.

prepares routine labor cost reports for submission to themanagement.


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Labor Turnover

Labor Turnoveris definedas the rate of change inthe composition of the labor force in anorganization.

E.g. where part-time and seasonal laboris employed ,

the rate is very high .


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CausesI Avoidable Redundancy due to seasonal fluctuations ,

contractionin the market or lack of proper planning

Dissatisfaction with the job , remunerations orworking conditions

Strained relationship with supervisor or fellow worker Lack of proper amenities like medical and other

facilities

Other f actors like - lack of proper training facilities,

inadequate security and retirement benefits


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II Unavoidable

Change in service forpersonal betterment

Retirement due to oldage andill health

Death

Incase of women employees , domesticresponsibilities ,marriage etc

Discharge ondisciplinary grounds orcontinuous

long absence


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EFFECT OF LABOR TURNOVER

A minimum of labor turnoveris quite normal andinevitable .

It is also desirable andgood for the health of the industry.

This makes room for the entrance of new blood in a firmandprevents stagnation in the work stream.

New wor kers bring new ideas and methods ofdoing work .

The % of normal labor turnovermay be placedbetween 3-5% depending upon the nature of the industry.

Labor turnoveris costly and generally should be minimized .


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Cost of Labor Turnover

I Preventive Cost :

The cost incurred on the efforts to keep the labor forcecontended, so that excessive labor turnover may beprevented:

Cost ofPersonnel Mgt : cost for maintaining good relationsbetween mgt and workers

Cost of Welfare Activities : canteen meals , co-operative

stores , transport facilities , housing schemes etc Cost of Medical Services

Cost ofPension Schemes: security and retirement benefits

Cost of Extra Bonus andotherPerquisites: LTA


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II Replacement Cost:

All such losses and wastages arising because of :

the inexperienced new labor force replacing the existingones and

the cost of recruitment and training of the new workers .

It includes : Loss of output due to time taken in getting new labor Loss of output and quality due to inefficiency of new labor Cost oftraining new workers

Cost oftools andmachine breakage Cost ofexcessive scrap anddefective work Cost ofaccidents

IDLE TIME h l f l b h


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IDLE TIME represents the loss of labor hours.Causes

I Productive Causes : controllable by proper planning

machine break down power failure waiting for tools and raw material waiting for work orinstruction

II Administrative Causes : abnormal situation such as surplus capacity ofP&M ,which neednot be put to

use because of low demand

III Economic Causes : beyondcontrol fall indemanddue to severe competition , seasonal nature of product ,


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Treatment of Idle Time in Cost Accounts

S.N. Idle Time Cost Accounting Treatment

1 Normal & Controllable Idle

Time

machine breakdown ; waiting

for work , tools , materials or

instruction to begin the work .

Treated as a part of

production overheads cost

2 Normal but Uncontrollable Idle

Time

set up time for machine ;

interval between one job and

the other ; personal needs

Treated as a part of the cost

and hence charged directly to

job by inflating wage rate

3 Abnormal Idle Time

power failures ; lock out ; fire ;

flood

Not treated as a part of the

cost and hence charged to

Costing Profit and Loss

Account


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Distinction between Time and Motion Study

Basis of

Distinction

Time Study Motion Study

Meaning

It is a technique which is

used to measure the time

that may be taken by a

workman of reasonableskills and ability to perform

various elements of task in a

job.

It is a technique

which involves

close observation

of the movementsof the body and

limbs required to

perform a job.

Purpose

To determine time normally

required to perform a certain

job and a fair days work for

the workman.

To detect and

eliminate wasteful

motions and

determine the best

way of doing a job.

O O


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LABOR REMUNERATION

I Time Rate System suitable :

Where output cannot be measured in quantitative terms e.g.watchmen , supervisoretc

Where a workis ofnon - standardized andnon-repetitive in

nature

Where the workdelays are frequent andbeyond the controlof employees

Where output is beyond the control of workers e.g.process industries

Where quality is more important than quantity

II Pi W R t S t it bl


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II Piece Wages Rate System suitable :

Where output can be measured

Where productionis standardized andrepetitive innature Where quantity is more important than quality

Where the workflow is regularanddelays are few

III Incentive Schemes

Under this the time rate and piece rate systems arecombined in such a way that workers are induced to

increase their productivity .The gains arising from the efficiency ofa workerare sharedbetween the workerand the employer.


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Direct Expenses

Expenses other thandirect material anddirect labour which can

be identified or linked with the cost centre:

Expenses for special moulds / dyes etc

Job processing charges Royalties in connection to a product

Factory Power and Light

Repair and maintenance ofmachines


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OVERHEADS

Overheadis definedas the aggregate of :

indirect material cost: consumable spares andparts , lubricants etc

indirect wages: salaries of staff in administration;

salary of security staffetc

indirect expenses: insurance , taxes and dutiesetc.


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Classification of Overheads

I Production Overheads

Cost of Lubricants

Consumable Stores

Indirect Salaries & Wages- production planning staff,technical supervisor, factory administration

Depreciation ofP&M and Factory Building

Insurance ofP&M and Factory Building

Security Expense

Packing Cost

Quality Control etc


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II Administrative Overheads

General Management Salary

Audit Fees

Legal Charges

Postage & Telephone

Stationery &Printing

Office Rent , Lighting, Insurance

Salary of Office Staff

Depreciation ,Repair& Maintenance of Office Building etc


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III Selling Overheads

Advertisement Cost

Salary and Commission to Sales Personal Showroom Expenses

Traveling Expense

Catalogues

Legal Expenses for Debt Realization

Market Research Cost

After Sale Service Cost etc


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IV Distribution Overheads

Secondary Packing Cost

Carriage Outwards Delivery Van Cost

Warehousing Cost of Saleable Products etc

V Research & Development Cost

Cost of developing new product / mfg process

Improvement of existing product / process / equipment


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Classification according to Behaviour or Variability

Fixed Overhead : remain unaffected by the change in thevolume of output.

Rent and Rates

Managerial Salaries Building Depreciation

Legal Expenses

Office Expenses


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ALLOCATION and APORTIONMENT


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ALLOCATION andAPORTIONMENT

of OVERHEADS

Allocation means charging the full amount of overheads to

a cost centre i.e. to a department ;

a process ;

a cost units etc

E.g. salary ofa foremanina productiondepartment can easilybe identifiedandallocated to that department.

Other such items are various indirect material , depreciation of

machinery overtime cost etc

Apportionment is the allotment of proportions of items ofcost to cost centres or cost units.

E.g. rent ofa building apportioned between the productionand

service departments.

Basis of Apportionment


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Basis of Apportionment

Overhead Cost Bases of Apportionment

1i Rent & other Building ExpenseFloor area

ii Lighting & Heating

iii Fire Precaution Services

iv Air Conditioning

2i Fringe BenefitsNumber of

workers

ii Labor Welfare Expenses

iii Time-keeping

iv Personnel Office

v Supervision


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4 General Overheads Direct labor hours ;

direct wages ;

machine hours5i Depreciation of P&M Capital Values

ii Repairs and Maintenance of

P&M

iii Insurance ofStock

6i Power /Steam Consumption Technical Estimates

ii Internal Transport

iii Management Salaries


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7 Lighting Expenses Number of light points ;

area

8 Electric

PowerHorse power of machines ,

number of machines hours

9i Material Handling Weight of material ;

Volume of material

ii Stores Overhead


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Thank you

Documents

Material, Labor,Ohd