Material Cost and Labour Cost PPT - Dr.J.Mexon

Includes Material Cost control and Labour cost control methods

1. COST ACCOUNTING(BBAA204A52) Unit -2 : MATERIAL & LABOUR COST CONTROL Dr.J.Mexon Department of Management, Kristu Jayanti College, Bengaluru.

2. Contents Material Control - Introduction Requisites of Material Control Objectives of Material Control Importance of Material Control Techniques of Material Control Issue of Materials Steps in Material Control Methods of Pricing Material Issues Labour Cost Idle Time Over Time Time Rate System Piece Rate System Taylor’s Differential Piece Rate System

3. Material Control - Introduction Introduction: The basic objective of cost accounting is cost control. This objective is attained by an effective control on each element of cost . Out of the three elements – material, labour and expense-the material element is the biggest or the highest proportion of the total cost of production Without proper control, materials have a tendency to grow beyond economic limits. Funds are tied up unnecessarily in surplus stores and stocks, productive operations are stalled, and finances of the plant are severely strained. Therefore the analysis and control on Material Cost is very important.

4. Material: Material is a substance (Physics term) that forms part of or composed of a finished product. i.e material refers to the commodities supplied to an undertaking for the purpose of consumption in the process of manufacturing or of rendering service or for transformation into products. The term ‘material’ refers to all commodities consumed in the process of manufacturing . Direct Material Indirect Material

5. Direct material: one or more items, matters or substances that are either physically transformed into a usable product or that become part or component of that product . The cost of such materials is directly traceable to each individual unit of product manufactured.   Indirect material: O ne or more items, matters or substances that are essential to carry out a production or manufacturing process but they don’t physically become the part of product or a component of it. I t can’t be easily and conveniently traced, linked or associated to a unit of product or a job order.

6. Stores: The term ‘Stores’ covers not only raw materials consumed or utilized in production but also such other items as sundry supplies, maintenance stores, fabricated parts, components, tools, consumables , lubricants etc. Finished and partly finished products are also often included under the term ‘Stores’.

7. Material Cost: Material cost is  the cost of materials used to manufacture a product or provide a service. Material cost is the significant constituent of the total cost of any product. It constitutes 40% to 80% of the total cost. The percentages may differ from industry to industry. But for manufacturing sector the material costs are of greatest significance. According to CIMA of UK, material cost is “the cost of commodities supplied to an undertaking.”

8. Material Control: “ Material control is a systematic control over purchasing, storing and consumption of materials , so as to maintain a regular and timely supply of materials , at the same time, avoiding overstocking.” It is also defined “providing the right quantity of material of the right quality at the right time and place at the minimum cost”.

9. Requisites of Material Control System Coordination and cooperation between the various departments Use of standard forms and documents in all the stages of control Classification, coordination, standardization and simplification of materials Planning of requirement of material Efficient purchase organization Budgetary control of purchases Planned storage of materials , physical control as well as efficient book control Appropriate records to control issues and utilization of stores in production Efficient system of Internal Audit and Internal Checks Report to the management regarding material purchase, storage and utilization

10. Objectives of Material Control To enable uninterrupted production: Ensure smooth and unrestricted production to avoid substantial loss to a concern due to production stoppage. To ensure requisite quality of materials: Exercise strict control and supervision over the purchases, storage and handling of materials for the better quality.

11. 3. To minimise wastage: introducing an efficient materials control system to minimize loss . 4. To fix responsibility: aims at fixing responsibility of operating units and individuals connected with the purchase, storage and handling of materials. 5. To provide information: provide accurate information regarding material cost and inventory

12. Needs of Material Control 1. For keeping the stock of raw materials within limits . 2 . It ensures proper storage of materials . 3. For knowing proper cost of production, control over materials 4. E nsuring optimum utilization of materials. 5 . In order to undertake continuous checking of materials (material control) 6. E nsures the availability of different kinds of materials without delay.

13. Techniques of material Control Some major techniques used for material management: ABC Technique VED Analysis Inventory Levels Economic Order Quantity (EOQ)

14. 1. ABC Technique ABC analysis divides an inventory into three categories—" A items" with very tight control and accurate records, "B items" with less tightly controlled and good records, and "C items" with the simplest controls possible and minimal records. The ABC analysis will have a significant impact on overall inventory cost, while also providing a mechanism for identifying different categories of stock that will require different management and controls. Examples of ABC class are 'A' items (Very important) – 20% of the items accounts for 70% of the annual consumption value of the items 'B' items (Important) – 30% of the items accounts for 25% of the annual consumption value of the items 'C' items (marginally important) – 50% of the items accounts for 5% of the annual consumption value of the items

15. 2. VED analysis VED analysis stands for Vital, Essential, and Desirable. It categorizes stock under three heads based on its importance and necessity for an organization for production or any of its other activities. V - VITAL CATEGORY - includes inventory, which is necessary for production or any other process in an organization. The shortage of items under this category can severely hamper or disrupt the proper functioning of operations.   E - ESSENTIAL CATEGORY - The essential category includes inventory, which is next to being vital . These, too, are very important for any organization because they may lead to a stoppage of production or hamper some other process.   D - DESIRABLE CATEGORY - The desirable category of inventory is the least important among the three, and their unavailability may result in minor stoppages in production or other processes.  

16. 3. Inventory Levels Minimum Level: the quantity which must always be maintained in hand. If stocks are less than the minimum level, then the work will stop due to shortage of materials. Following factors are considered while deciding minimum stock level: 1 .      Lead Time: 2 .      Rate of Consumption: 3 .      Nature of Material: 4 .      Re-ordering Level: Maximum Level: It is the quantity of materials beyond which a firm should not exceed its stocks. If the quantity exceeds maximum level limit, then it will be termed as overstocking. A firm avoids overstocking because it will result in high material costs.   Danger Level: It is the level below which stocks should not fall in any case . If danger level approaches, then immediate steps should be taken to replenish the stocks.   Re-ordering Level: When the quantity of materials reaches a certain level then fresh order is sent to procure materials again. Reordering level is fixed between minimum level and maximum level.

17. 4. EOQ Economic order quantity (EOQ) is the ideal order quantity a company should purchase to minimize inventory costs such as holding costs, shortage costs, and order costs. This production-scheduling model was developed in 1913 by Ford W. Harris and has been refined over time. The goal of the EOQ formula is to identify the optimal number of product units to order . If achieved, a company can minimize its costs for buying, delivery, and storing units.

18. Issue of Materials (a) Authorisation of issues: Since materials represents money, for the issue of materials there must be some authorisation by responsible officers nominated by the management . The object is to avoid misunderstanding and unpleasantness that may arise due to the refusal by the storekeeper to issue materials. The request for issue of materials is invariably made in written form or documents for proper authorisation.

19. ( b) Identification of requirements: use intelligence to identify the mistake and suggest to the indenter the correct item. Details about materials requirements such as part number, code number, etc. ensure that it is supplied without delay and unnecessary correspondence . (c) Timing of issues: The stores manager should ensure that the indenting departments are fully aware of the timing of issues . S tore-keeper should study carefully the requirements of various departments and stagger (spread) the timings in such a way that each department can draw their requirements without loss of time.

20. Steps in Material Control 1. Purchase Requisition : 2. Selection of Suppliers: 3. Purchase Order and Follow-Up: 4 . Receipt of Materials: 5. Inspection and Testing of Materials: 6 . Return of Rejected Materials : 7. Passing Invoices for Payment:

21. 1. Purchase Requisition: Purchases of materials are initiated through purchase requisitions . It is a formal request by the head of the department or other authorities to the purchase manager to purchase the specified materials. 2 . Selection of Suppliers: When the purchasing department receives a duly authorised purchase requisition, a source of supply has to be selected. The purchase department generally maintains a list of suppliers for each type of material and selects a particular supplier after inviting tenders .

22. 3. Purchase Order and Follow-Up: The purchase order is the form used by purchasing department authorising the suppliers to supply the specified materials at a price and terms stated therein . A purchase order should be carefully prepared as it forms a basis of legal contract between the parties concerned. For this reason, authority to sign purchase orders should also be restricted to selected responsible officials. 4 . Receipt of Materials: All incoming material should be received by the receiving department . This department performs the functions of unpacking the goods received and verify their quantities and conditions. The quantity is checked against the purchase order copy and the supplier’s advice note which is normally received along with the goods.

23. 5. Inspection and Testing of Materials: Goods received should be inspected for quantity to ensure that they comply with specifications stated on the purchase order . Where technical or laboratory inspection is necessary, the goods are passed to laboratory which will provide a report on the quality of goods . In either case, the report is forwarded to the purchasing department. 6. Return of Rejected Materials: Where materials received are damaged or are not in accordance with the specifications, these are usually returned to the supplier along with a debit note.

24. 7. Passing Invoices for Payment: When the invoices are received by the purchasing department, the process of assembling the business paper concerned with each purchase and preparation of vouchers begins. Invoices are numbered serially and entered in the invoice register.

25. Methods of Pricing Material Issues 1. First in First Out Method 2. Last in First Out Method 3. Simple Average Cost Method 4.Weighted Average Cost Method

26. 1. First In First Out Method (FIFO) : A method of pricing the issue of material using, the purchase price of the oldest unit in the stock. Under this method materials are issued out of stock in the order in which they were first received into stock . It is assumed that the first material to come into stores will be the first material to be used .

27. Advantages: (a) It is easy to understand and simple to price the issues. (b) It is a good store keeping practice ( c) It is a straight forward method which involves less clerical cost ( d) Acceptable under standard accounting practice . (e) It is a consistent and realistic practice in valuation of inventory and finished stock.

28. Disadvantages: There is no certainty that materials which have been in stock longest will be used , if they are mixed up with other materials purchased at a later date at different price. It involves more clerical work and there is possibility of errors . In a situation of rising prices, production cost is understated . In inflationary market , there is a tendency to underprice material issues . In deflationary market , there is a tendency to overprice such issues . Usually more than one price has to be adopted for a single issue of materials. C ost comparison difficult because of varying prices for the same materials.  

29. 2. Last In First Out Method (LIFO): Under this method most recent purchase will be the first to be issued . The issues are priced out at the most recent batch received and continue to be charged until a new batch received is arrived into stock. It is a method of pricing the issue of material using the purchase price of the latest unit in the stock .

30. Advantages: (a) Stocks issued at more recent price represent the current market value based on the replacement cost. (b) It is simple to understand and easy to apply. (c) Product cost will tend to be more realistic since material cost is charged at more recent price . (d) In times of rising prices, the pricing of issues will be at a more recent current market price . (e) It minimizes unrealized inventory gains and tends to show the conservative profit figure and provides a hedge against inflation .

31. Disadvantages: (a) Valuation of inventory under this method is not acceptable in preparation of financial accounts . (b) It is an assumption of a cash flow pattern and is not intended to represent the true physical flow of materials from the stores . (c) More than one price may have to be adopted for an issue. (d) It renders cost comparison between jobs difficult. (e) It involves more clerical work and sometimes valuation may go wrong. (f) In times of inflation , valuation of inventory under this method will not represent the current market prices.

32. 3. Simple Average Cost Method: Under this method all the materials received are merged into existing stock of materials, their identity being lost. The simple average price is calculated without any regard to the quantities involved . The simple average cost is arrived at by adding the different prices paid during the period for the batches purchased by dividing the number of batches .   4. Weighted Average Cost Method: It is a perpetual weighted average system where the issue price is recalculated every time after each receipt taking into consideration both the total quantities and total cost while calculating weighted average price. The issue price calculated rarely represents the actual purchase price.

33. Labour Cost Workers contribute to the concerns through their time and energy. This needs adequate compensation to them. The compensation is known as ‘ wages or labour cost ’. The basic factor which gives rise to the labour cost is the remuneration paid to workers . Labour Cost is also called as Employee Cost. It should be remembered that Labour is not like material as there is a human aspect involved in it. Attention should also be paid to the productivity aspect. Low productivity results in higher Labour Cost per unit while higher productivity will reduce the Labour Cost per unit .

34. Direct Labour : Direct labour is that labour which is directly engaged in the production of goods or servic es and which can be conveniently allocated to   the  job, Process or community unit . Indirect Labour : Indirect labour is that labour which is not directly engaged in the production of goods and services but which indirectly helps the direct labour engaged in production.

35. Idle time Idle time represents time lost (wasted) by the workers. When workers are paid based on time, there may be some difference between the time paid for and the time actually spent on production . The difference is known as ‘idle time’. Idle time refers to the time for which they are paid but no production is obtained. This is a wastage, which needs some effective control. Idle time is categorized into two. They are; ( a) Normal idle time due to unavoidable factors and ( b) Abnormal idle time caused by avoidable factors.

36. (a) Normal Idle Time: Normal idle time cannot be totally avoided. Therefore, it is borne by the employer. Normal idle time such as waits for jobs, tools, materials or instructions, small power failures, small breakdown of machines and tools, and atmospheric conditions   (b) Abnormal Idle Time: Abnormal idle time arises due to reasons in no way connected with usual routine manufacture and for which management must pay. For example, time lost due to strikes and lockouts , time lost in waiting for raw material etc.

37. Causes of idle time: a) Administrative Cause: Idle time is sometimes arising out of administrative decisions . During the period of depression, the management may abandon some products from the product line temporarily. The regular workers are not sent out during these periods. b) Productive Cause: Idle time is arising out of many productive causes . Machine breakdown, power failures , waiting for tools or raw materials, delay due to work order and delay due to instructions are some causes brought under the category. c) Economic Cause: Fall in the demand for your product is one of the major economic reasons, which gives rise to idle time. This may be due to severe competition or seasonal character of your product.

38. Over Time It refers to a work done by an employee beyond normal working hours. The Factories Act lays down the rules for normal working hour. Any employee working for more than 9 hours per day or more than 48 hours per week is entitled to overtime payment. As per CAS-7, the overtime. Overtime premium is defined as ‘Overtime is the time spent beyond the normal working hours which is usually paid at a higher rate than the normal time rate. The extra amount payable beyond the normal wages & salaries for beyond the normal working hours is called Overtime Premium’.

39. Disadvantages of Overtime Work: It leads to excessive labour cost Diminishing labour efficiency gives rise to deteriorating labour productivity It has a bad effect on the health of workers Excessive use of plant and machinery gives rise to high wear and tear There will be escalation of factory overhead. e.g., lighting etc . Widespread discontent among workers due to uneven distribution of overtime is another demerit.

40. Control over the Overtime Work: O vertime is not allowed when normal output is not achieved during normal working hours. The competent authority feels justified to sanction overtime work. Rate of output achieved during the overtime period should be compared with rate of output during the normal period to control the over time period. If possible an upper limit of overtime should be fixed for each category of workers. Periodical reports on overtime work sent to the top management for taking corrective action, if needed.

41. Time Rate System Under this system, the wages are paid according to the time spent by workers irrespective of his output of work done. The wage rates are fixed for an hour, a day, week, a month or even a year. Time wage system is suitable under following situations: When productivity of an employee cannot be measured precisely. Where quality of products is more important than the quantity produced. Where individual employees do not have any control over production. Where close supervision of work is possible.

42. Types: 1.Flat time rate method: Under this method, workers are paid at a flat rate on the basis of time they are employed . The flat rate may be per hour, day, week or month . 2. Highday Rate: The rate of wages is fixed by hour or day but the rate fixed is relatively higher. Higher rate is given to attract the efficient workers who can easily be motivated to achieve pre-determined standards of efficiency which are relatively fixed at higher level.

43. 3. Measured day rate: The workers under this method are given a specified work to be performed and the rate is fixed in accordance with the level of performance specified by the employer. 4. Graduated time rate: Under this method the rates of wages are linked up with the cost of living index. Thus, the rate per hour or day fixed initially goes on changing with the changes in the cost of living index. 5. Differential time rate: Under this method, different rates of wages are fixed for different workers in the same group according to the differences in their personal abilities and skill.

44. Time Rate System ADVANTAGES: 1. Simplicity: 2. Security: 3. Batter Quality of Products: 4. Support of Unions: 5. Beneficial for Beginners: 6. Less, Wastages: LIMITATIONS: 1 . No Incentive for efficiency : 2. Wastage of time: 3 . Low production: 4 . Difficulty to determine labour cost: 5 . Difficult supervision work: 6 . Employer-employee trouble:

45. Piece Rate System Under piece system of payment , wages are based on output and not on time . There is no consideration for time taken in completing a task. A fixed rate is paid for each unit produced, job completed or an operation performed. Workers are not guaranteed minimum wages under this system of wage payment. The payment by result system is successful only if the work is of repetitive nature . This method is suitable in the following cases; Quality of work is not important Work is of repetitive nature Quantity of work can be measured Where it is not possible to control effectively the wasting of time by workers.

46. Straight Piece rate system: Under straight piece rate system workers are paid according to the number of units produced at a fixed rate per unit. Differential Piece rate system: Two or more rate are offered to workers . Higher performance is paid at a higher rate and lower performance is paid at lower piece rat e. Simply different wages for different levels of performance.

47. ADVANTAGES: 1 .  Workers are paid according to their merits . An efficient worker can earn more wages. 2. W orkers will try to adopt better methods of production to earn more wages . 3. Increased production will reduce cost of production, allowing a greater margin of profit. 4. Idle time is not paid for as is the case under the time wage system. 5. The employer is able to know his exact labour cost per unit . 6. Workers use their tools and machinery with a greater care . 7. Less supervision is required . 8. Inefficient workers are motivated to become efficient .

48. DISADVANTAGES: 1.   Considerable difficulty is experienced in fixing a suitable piece work rate. 2 . Q uality of the output will suffer because workers try to produce more. 3. T he efforts to increase the production cause more wastage of materials. 4. Increased production does not necessarily mean lower cost of production . 5 . It will not reduce the labour cost per unit because the same rate will be paid. 6. Workers have the fear of losing wages . 7. Workers may work for long hours, may spoil their health. 8. Workers absent themselves for a few days , upsetting the uniform flow of production. 9. Workers in the habit of producing quality goods will suffer. 10. The system will cause discontentment among the slower workers.

49. Taylor’s differential Piece Rate system F.W. Taylor’s, the father of scientific management, introduced this system. According to this system: ( a) There are two piece rate systems- one is lower and the other is higher. ( b) Lower piece rate is for the output below the standard and higher piece rate is for the output above the standar d. For each job, standard time is stipulated . Taylor was of the view that an inefficient worker should have no place in the organization and he should be compelled to leave the organization by paying him a low piece rate for low production.