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Paper 4 Session 5

MATERIALS

Lecturer: Nguyen Thu Hang

BCom (UNSW)

CPA Australia ASA

Certifed Accounting Technicians

1Nguyen Thu Hang (BCom, CPA Aus ASA)3/1/2010

Readings requirement

Chapter 5 Interactive Kit

Practice & revision Kit pg19-24

3/1/2010 Nguyen Thu Hang (BCom, CPA Aus ASA) 2


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What will be covered

Types of Materials1

Buying materials2

Valuing materials3

Inventory control4


Reordering inventory5

Recall from last week: Product cost

The cost of an item can be divided into the following cost elements

Materials

Labour

Expenses

Each element can be split into two: direct and indirect

Materials = Direct materials + Indirect materials

+ + +

Labour = Direct labour + Indirect labour

+ + +

Expenses = Direct expense + Indirect expense

Total cost Direct cost Overhead

3/1/2010 4Nguyen Thu Hang (BCom, CPA Australia ASA)


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Wooden-table manufacture

Raw materials are: pinewood, white paint,screw, glue, varnish, lubricant

WIP: 4 table legs, unpainted table, tablehas not been varnished

Finished good: fully painted table readyfor dispatch for customers or display in

store for sale


Some other examples

Think of raw materials, WIP and finishedgoods in:

A book publishing company

A music record company

An audit firm



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2. BUYING MATERIALS


Purchasing procedure



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Material issuance procedure


Issue requiredmaterials

Purchase documentations


Purchaserequisition

form

Filled in by department in need of materials Routed to Purchase department

Order form

Filled in by Purchase department Sent to desirable suppliers

Deliverynotes

Prepared by supplier or transporter Copies kept by warehousing department

GRN

Prepared by warehousing department Routed to accounts department and purchase department for

notice


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Example_purchase requisition form

(RQF)


Example_Purchase Order


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Example_ Goods received Note (GRN)


Material Input requirement

How much/How many to buy is a key question for bothrequesting department and Purchase department

Usually, organisations have to buy extra materialsbecause wastage may occur as a matter of course insome production process



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3. VALUING MATERIALS


Inventory policy/approach


Just in-time(JIT) is anapproach wherethe holding levelof inventory/material isZERO

2 approaches

Buffer Inventoryis an approach tokeep a certainamount ofinventory to copewith flux fromdemand andunstable suppliers

This is themost

importantelement to

study at yourlevel


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Inventory valuation methods


First in,first out

FIFO

Last in,first out

LIFO

Moving weightedaverage

Periodic weightedaverage

Weighted

average

FIFO

Advantage

It is logical pricing methodwhich probably representswhat is physicallyhappening: in practice, the

oldest inventory is likely tobe used first

It is easy to understandand explain to managers

The closing inventoryvalue can be near to avaluation based on thecost of replacing inventory

Disadvantage

FIFO can becumbersome to operatebecause of the need toidentify each batch ofmaterials seperately

Managers may find itdifficult to compare costsand make decisions whenthey are charged withvarying prices for thesame materials



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LIFO

Advantage

Inventories are issued at aprice which is close tocurrent market value. Thisis not the case with FIFOwhen there is a high rateof inflation

Managers are continuallyaware of recent costs

when making decisions,because the costs beingcharged to theirdepartment or productswill be current costs

Disadvantage

LIFO can be cumbersome tooperate because it sometimesresults in several batches beingonly partly used in the inventoryrecords before another batch isreceived

LIFO is often the opposite towhat is physically happening

and can therefore be difficult toexplain to managers

As with FIFO, decision-makingcan be difficult because ofvariations in prices


Weighted average pricing method

Advantage

Fluctuations in price aresmoothed out, making iteasier to use the datafor decision making

It is easier to administerthan FIFO or LIFObecause there is noneed to identify eachbatch separately

Disadvantage

The resulting issue price israrely an acutal price thathas been paid for and canrun to several decimal

places. Prices tend to be lag a little

behind current market valueswhen there is gradualinflation



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4. INVENTORY CONTROL


Inventory cycle


Store/warehouseto receive and

stockmaterials/inventory

Supplier tosend goods

Purchaseorders

Inventory todeliver to

customers

Reorderinventory

Inventory/Materialsissuance

Materials tobe used inproduction


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Ordering cost

Costs associated with low level ofinventory as more frequent orders willhave to be placed. Includes:

Clerical and administrative costs

Transportation cost

Production run cost


Holding costs

Costs associated with high level ofinventory. Happens for several reasons:

Cost of storage and store operations

Interest charge

Insurance cost

Risk of obsolescence

Deterioration and damages

Theft



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Stock-out cost

Associated with no stocks available forcustomers sale. Some damages can arise fromstock-out situation: Loss of Customer Goodwill

Extra costs of urgent, small quantity, replenishment orders

Labour frustration over stoppage

Lost Contribution from lost sales

Loss of Future sales due to disgruntled customer

Expense of production stopage


Objectives of Storing Materials



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How to achieve those objectives?

Inventory recording system: Periodic vs.Perpetual

via Bin Card or Computerised System

Inventory coding and Locating

Stocktaking

Reconcile floor to records

Physical conditions of inventory

Inventory discrepancies Floor more than recordsWhy?

Floow less than recordsWhy?


5. REORDERING INVENTORY



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Objectives of Optimum level of inventory

Business hold too many inventoriesholding costs

Business hold too few inventories stockout costs


Inventory control level

Can be calculated in order to maintaininventories at the optimum level

4 critical control levels are: Reorder level

Reorder quantity Min inventory control level

Max inventory control level


Refer toExample 5.1 Pg84-86 Interactive

Text


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Class exercise 1

Milk powder is used by a company in the manufacture of oneof its product, Fruit Yoghurt. Demand for Fruit Yoghurt foryear 2010 is forecast to be 26,000 units.

Each finished unit of Fruit Yoghurt contains 0.72kg of Milkpowder. There is a preparation of loss of 10% of powderused. It is not planned to change the stock-holding of FruitYoghurt in 2010 but a reduction of 1,000 kgs in the stock ofMilk powder is planned.

Required:

Calculate the quantity of Milk powderthat needs to be purchased in 2010


Class exercise 2

Fresh milk is used in the making of Fruit cakes and other chocolateproducts. The total annual requirement for Fresh Milk is 120,000litres, used evenly over each year

The costs of ordering stock and holding stock are as follows:

Ordering: $45 per order Holding: $0.30/litre/year

A safety inventory of 2,500 litres of Fresh Milk is held and the avg.lead time is 1.5 weeks

Required: Calculate for Fresh Milk the:

1. Economic Order Quantity

2. Reorder level

3. Total annual cost of ordering inventory

4. Total annual cost of holding inventory



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Next week: Chapter 6 Labour

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