Cost Accounting · Ch 2 — Material
Control of Material
Control of Material
Materials control is the systematic regulation of the purchase, storage and use of material, so that a steady, uninterrupted supply is available for production at the lowest possible cost — without either running out of stock or locking up excessive capital in idle stock. Several tools work together to achieve this control.
1. Fixation of stock levels
To signal exactly when to buy and how much stock to hold, the following levels are fixed for each important item (expressed here in words; worked numerical problems appear in the Questions for Practice section):
| Level | Meaning | Formula (in words) |
|---|---|---|
| Re-order Level (ROL) | The level at which a fresh purchase requisition must be raised | Maximum Consumption × Maximum Re-order Period |
| Minimum Level | The lowest stock normally allowed | Re-order Level − (Normal Consumption × Normal Re-order Period) |
| Maximum Level | The highest stock normally allowed | Re-order Level + Re-order Quantity − (Minimum Consumption × Minimum Re-order Period) |
| Average Stock Level | The typical stock carried | Minimum Level + ½ × Re-order Quantity |
| Danger Level | Emergency level below Minimum, triggering urgent purchase | Average Consumption × Emergency Lead Time |
(The Normal Re-order Period used in the Minimum Level formula is the average of the minimum and maximum re-order periods.)
2. Economic Order Quantity (EOQ)
Economic Order Quantity (EOQ)
EOQ is the order size that minimises the combined total of ordering cost and carrying cost. It is computed as the square root of (2 × Annual Usage in units × Ordering Cost per order) ÷ Carrying Cost per unit per annum — written as EOQ = √(2AO ÷ C).
Ordering material too often keeps carrying cost low but pushes up ordering cost; ordering in very large lots does the reverse. EOQ is the balancing point. A useful check on any EOQ answer: at the EOQ, the total ordering cost for the year exactly equals the total carrying cost for the year.
3. ABC Analysis (selective control by value)
ABC Analysis
ABC Analysis is a technique of selective control that classifies materials into three categories — A, B and C — according to their VALUE (annual usage value), so that the costliest few items receive the tightest control.
- Category A — a small number of items (say ~10% of items) accounting for a large share of total value (say ~70%): controlled very tightly, with low stock, frequent ordering and close monitoring.
- Category B — a moderate number of items (~20%) accounting for a moderate value (~20%): controlled with moderate, routine attention.
- Category C — a large number of items (~70%) accounting for a small value (~10%): controlled loosely, in bulk, with simple two-bin or bulk ordering.
The principle is 'control by importance and exception' — concentrate effort where the money is.
4. VED Analysis (selective control by criticality)
VED Analysis
VED Analysis classifies materials — especially spare parts — into Vital, Essential and Desirable, according to how CRITICAL the item is to production if it runs out, rather than according to its money value.
- Vital (V) — items whose stock-out halts production entirely; held in adequate stock at all times.
- Essential (E) — items whose stock-out causes serious but not total disruption; held in reasonable stock.
- Desirable (D) — items whose absence causes only minor inconvenience; held in minimum stock.
VED is especially useful for spare parts, where a cheap part (low ABC value) can still be vital to keep an expensive machine running.
5. Stock (Material) Turnover Ratio …
The order quantity that minimises the combined total of ordering cost and carrying cost; EOQ = √(2 × Annual Usage × Ordering Cost per order ÷ Carryin …
Selective control classifying materials into A (few, high value — tight control), B (moderate) and C (many, low value — loose control) by …
Selective control classifying items (especially spares) into Vital, Essential and Desirable by how critical a stock-out would be to produc …
Cost of Material Consumed ÷ Average Stock; measures how many times average stock is consumed in a period. A high ratio is good; a low ratio w …