MATERIALS PLANNING:

Success of operations department of any organization is dependent upon an

efficient production plan. One of the key essentials of a production plan is

material and production planning system. Material planning plays a pivotal role

in assembly-line production. The primary purpose of existence of a

manufacturing organization is production. Any manufacturing organization deals

with procuring the raw material, undertaking activities required to manufacture

the product and delivering the finished product to the customers. All these

activities are not as simple as they sound to be. It involves good amount of

planning. This is where material planning comes into picture.

Thus material planning is a scientific way of determining the requirements

interms of raw materials, components, spares and other items that meet the

production needs within economic investment policies. Material planning serves

as the subset of the overall planning activity.

A crucial aspect of the entire production mechanism is material planning.

Material planning is something that plays a very important role in the operations

and production dimensions that is why it needs to be dealt with effectively. It is

absolutely pivotal to keep accurate track of the material needs of the

organization. If a company fails to do so, then the compensation costs that the

organization would need to pay would be quite pricey and severe. Dealing with

material planning, a company encounters a diverse range of aspects, some of

which are very important. For example, lot sizes and set up time is very

important dimension of material planning. Not only that the issue of outside

members of the supply chain holds great importance too. Material planning is

derived from the overall organizational planning and hence it is always a sub-

plan of the broad organization plan. The factors which affect materials planning

can be classified into two categories – macro factors and micro factors:

Macro factors:

Macro factors are also known as external factors. Some of the macro factors are

discussed below:

National economy: This is measured by gross domestic production in

which production of all sectors is added up by central statistical

organization. It is one of the indicators of the health of economy.

Price trends: this follows law of demand and supply.

Monetary and fiscal policies of government: It involves credit

regulation and the guidelines regarding import, export, licensing and

liberalization etc. Credit policy of the government is a critical factor as

banks follow these guidelines only while extending financial support to

business entities.

Business cycles: It involves the phases through which the economy of a

nation passes for example the recession or inflationary tendencies.

Micro factors

The material planner also has to take various micro level factors into account.

These factors exist within the organization such as corporate policy on inventory

holding, production plan, lead time of procurement, acceptable inventory levels,

working capital, seasonality, delegation of power, rejection rates and

communication system etc.

MATERIAL PLANNING TECHNIQUES:

The techniques of materials planning are:

(a) Bill of Materials Explosion and

(b) Past Consumption Analysis.

(a) Bills of materials explosion:

The planning for materials management is aimed at determining the demand for

the end-products. This is possible only through farsightedness or forecasting.

Therefore, forecasting forms “the basis for materials planning. There are various

techniques for forecasting. These techniques are equally applicable to demand

forecasting as well.

The techniques are:

Moving averages method.

Exponential smoothing

Time series

After the demand forecast, the exercise of materials planning starts.

Requirements for various materials are ascertained from the demand forecast.

For this purpose, the bill of materials is used through explosion charts. Here the

use of computers is very effective for the “exploding” bill of materials with

demand forecasts. The bill of materials is prepared and issued by the planning or

engineering department in a standard form.

An explosion chart is just a series of bills of materials grouped together in a

matrix form so that combining the requirements for different components can be

done. Materials planning are usually made for a short period on a quarterly basis

and at the beginning of every quarter; it is quite natural to find that some

materials are in short supply and some in excess. This can be ascribed to the

wrong forecasting.

To rectify such errors in the estimation of materials, quarterly planning is

resorted to. In engineering industries, even quarterly planning seems to be too

long and realistic order is placed with the suppliers.

 

(b) Past Consumption Analysis:

For continuously needed materials and the materials where no bill of materials is

possible, this technique of analysis is adopted. The past consumption data is

analyzed and a projection for the future on the basis of past experience and

future needs is made. To prepare such a projection, “average” or “mean”

consumption and the “standard deviation” are taken as bases and as guidelines

for each item.

These are all statistical tools and are very effective to absorb the stock of

fluctuation in consumption of direct and indirect materials where no

straightforward norms of consumption can be formulated. In the process

industries, this technique is particularly suitable.

Material Requirements Planning

Material requirements planning (MRP) is a planning and control system for

inventory, production, and scheduling. MRP converts the master schedule of

production into a detailed schedule, so that the raw materials and components

can be purchased. Used mostly in the manufacturing and fabrication industries,

this system is a push type of inventory control, meaning that organizations use

forecasting to determine the customer demand for products. The manufacturing

company will forecast the amount and type of products they will purchase, along

with the quantity of materials to produce them. They then push the products to

the consumers. This contrasts with a pull system, where the customer first places

an order. The main disadvantage of a push system is its vulnerability when sales

vary. In this scenario, the forecasts become inaccurate, which for manufacturing,

cause either a shortage of inventory or an excess of inventory that requires

storage. 

Inventory is divided into two categories, independent and dependent demand.

Independent demand is a desire for finished products, such as cell phones or

automobiles, whereas dependent demand is the demand for components, parts,

or incomplete assemblies (sometimes called sub-assemblies), such as phone

screens or tyres for automobiles. We determine quantities for the dependent

demand by determining quantities for the independent demand. For example, if

we forecast independent demand for the number of completely assembled cell

phones that we expect to sell, we can forecast the quantities of the dependent

demand materials, such as screens, processors, batteries, and antennas. These

part quantities depend on the quantity of cell phones we want to produce. This

relationship between the materials and the finished product are shown on a bill

of materials (BOM) and are calculated with MRP. 

The three key questions that are asked when planning for dependent demand

are:

What components do we need?

How many of each component do we need?

When do we need the components?

In determining how much material our product needs, MRP differs from

consumption-based planning (CBP). MRP logic uses information received either

directly from customers or from the sales forecast, calculating the material

required based on the dependencies of other materials. CBP calculates material

requirements only via historical consumption data. CBP does not consider the

dependencies between different materials, as it presumes that future

consumption will follow the same pattern that the historical data did. 

MRP synchronizes the flow of materials, components, and parts in a phased

order system, considering the production schedule. It also combines and tracks

hundreds of variables, including purchase orders, sales orders, shortage of

materials, expedited orders, due dates, forecasts, marketplace demand, material,

inventory, data and bill of material

For all companies, MRP has a few goals in common. These include making sure

that the inventory level is at a minimum, but high enough to provide for the

customer need, and that we plan all of the activities, including delivery,

purchasing, and manufacturing. 

There are some terms that will come up in MRP repeatedly. Some are terms

related to MRP as a concept, and some are specific to MRP software. These terms

are as follows:

Item: In MRP, an item is the name or code number used for the event we

are scheduling.

Low-Level Code: This is the lowest level code of an item in the bill of

materials and indicates the sequence in which we run items through an

MRP. We use low-level code because an MRP system recognizes and

connects the level that an item appears in the product chain and uses it to

plan the proper time to meet all of the system demands.

Lot Size: This is the quantity of units we order during manufacturing

Lead Time (LT): This is the time we need to assemble or manufacture an

item from beginning to end. Two types of lead time are ordering lead time

and manufacturing lead time. Ordering lead time is the time it takes from

starting the purchase  to receiving the purchase. Manufacturing lead time

is the time it takes for the company to completely manufacture a product

from start to end.

Past Due (PD): This is the time during which we consider orders behind

schedule.

Gross Requirements (GR): We generate this MRP calculation through

forecast scheduling using the number of produced units, the amount of

required material for each produced unit, the current stock, and the

ordered stock /stock in transit. This is the total demand for an item

during a specific time period.

Scheduled Receipts (SR): These are the open orders for products that

the company currently possesses but has not yet fulfilled.

Projected on Hand (POH): This is the amount of inventory we have

estimated to be available after we meet the gross requirements. To

calculate this sum, we add the POH from the previous time period to the

scheduled order receipts and the planned order receipts and then

subtract the gross requirements. (Current POH = Previous POH + SR +

POR – GR)

Net Requirements (NR): We generate this MRP calculation through

master scheduling using gross requirements, on-hand inventory, and

other quantities. This is the actual, required quantity to be produced in a

particular time period.

Planned Order Receipts (POR): This is the quantity of orders during a

time period that is expected to be received. This planning for orders

keeps the inventory from going below the threshold necessary.

Planned Order Releases (PORL): This is the amount we plan to order

per time period. This is POR offset by the lead time.

Cumulative Lead Time: This is the greatest amount of time that it takes

to develop the product. We may calculate it by looking at each BOM and

figuring out which one takes the longest.

Product Structure Tree: This is a visual depiction of the bill of materials,

showing how many of each part and how many sub-parts we need to

produce the product.

Net-Change Systems: These are systems, which identify only the changes

between the new and old plan.

Master Production Schedule (MPS): This is the schedule of finished

products that drives the MRP process. The quantities in MPS represent

what we need to produce to meet the forecast.

Lumpiness: This is when product/material that is low or at zero

suddenly spikes. Examples of lumpy or uneven demand include the need

for service parts. You only need service parts when an appliance breaks,

so forecasting the need for the parts may be difficult, as the demand is not

continuous. 

Time Fence: Time fences are boundaries between different MRP

planning periods. They offer the opportunity for programming changes,

such as rules and restrictions. 

Material Requirements Planning Steps and Processes

MRP works because it is a well-organized framework of processes and

calculations. An MRP system can completely transform a company’s operational

procedures. Many people within an organization contribute to the MRP process,

including sales, production, purchasing, receiving, stockroom, and shipping

personnel. 

MRP consists of three basic steps: 

Identifying the Quantity Requirements: Determine what quantity is on

hand, in an open purchase order, planned for manufacturing, already

committed to existing orders, and forecasted. These requirements are

specific to each company and each company location and change with the

date.

Running the MRP Calculations: Create suggestions for materials that we

consider critical, expedited, and delayed.

Complete the Orders: Delineate the materials for the manufacturing

orders, purchase orders, and other reporting requirements. 

                    

The calculations that MRP performs are based on the data inputs. As shown in

the diagram above, these data inputs include:

Customer Orders: This refers to the specific information we receive from

customers and includes one-offs and regular ordering patterns.

Forecast Demand: This is a prediction from the marketplace about how

much probable demand there will be for a product or service. It is based

on historic accounting and current trend analysis. 

Master Production Schedule (MPS): Both forecast demand and

customer orders feed into the master production schedule. The MPS is a

plan that a company develops for production, staffing, or inventory. It is

the production future plan that includes the quantities we need to

produce the products in a specified time period. It also includes inventory

costs, production costs, inventory information, supply, lot size, lead time,

and development capacity.

Bill of Materials (BOM): Also called a product structure file, this includes

the details and quantities of the raw materials, assemblies, and

components that make up each end product.

Inventory Records: These are the raw materials and the completed

products that you either have on hand or have already ordered. 

After MRP receives the input, it generates the output. There are four main

outputs. These include: 

Purchase Orders (PO): This is the recommended purchasing schedule

that includes the order we give to suppliers to send the materials. The PO

includes a schedule with quantities and start as well as finish dates to

meet the MPS.

Material Plan: This details the raw materials, assembly items, and

component needs to make the end products with quantities and dates. We

use attribute settings to set the time fences and to firm orders.

Work Orders: This details the work that goes into producing the end

product, including which departments are responsible for what part, what

materials are necessary, and what the start and end dates are.

Reports: MRP generates primary and secondary reports. The primary

reports include all three of the above — those that deal with production

and inventory planning and control. Secondary reports are those that

detail things, such as performance control, exception data (e.g., errors or

late orders), deviations, and predictors of future inventories and

contracts.

The MRP technique can be vague at times because we call it a calculation process

without necessarily indicating how to compute the data outputs. MRP is about

putting mathematical controls into place using formulas that yield optimal

results. MRP is an optimal control problem that calculates the initial conditions,

the dynamics, the constraints, and the objective. The variables are the local

inventory, the order size, the local demand, the fixed order costs, the variable

order costs, and the local inventory holding costs. MRP comprises many methods

and calculations. To find the order quantities, we can use any number of

methods. Three of the most popular are:

Dynamic Lot-Sizing: In inventory theory, this model assumes that the

demand for product fluctuates over time. This complex algorithm

generalizes the economic order quantity model. It requires dynamic

programming to perform, so mathematicians also developed the following

models.

Silver-Meal Heuristic: This is an inventory control algorithm, also called

least period cost that minimizes the total relevant cost per unit of time. In

other words, we use it to calculate the production quantities needed to

meet the operational requirements at the lowest cost possible. 

Least-Unit-Cost (LUC) Heuristic: Although quite similar to Silver-Meal,

LUC chooses the period in the future based on average cost per unit

rather than on average cost per period.

Manufacturing Resource Planning

Specific to the manufacturing industry is manufacturing resource planning (MRP

II). MRP was so successful that organizations using it wanted more

improvements and more automation. MRP II takes the principles of MRP and

adds some additional areas, such as rough-cut capacity planning and capacity

requirement planning (CRP), to give companies a comprehensive manufacturing

plan. CRP is an accounting method that determines the load for each process

according to the manufacturing order. CRP takes data from MRP. 

MRP II isn’t solely about the computational needs, but is a management concept

that can take many forms. MRP II works within a hierarchy that divides planning

into the long range, medium range, and short term. The three main

characteristics of MRP II are: 

A company-wide system

A financially and operationally integrated  system

A system with the ability to perform “what-if” scenarios that show

different ways to do things

MRP II also relies on the quality and timeliness of the input data. Inaccurate

information or consistent lead-time fluctuations result in poor planning. These

plans can lead to execution failure and even reimplementation. 

Enterprise Resource Planning

Enterprise resource planning (ERP) is an extension of MRP systems that came

about in the 1990s. MRP is a planning and control system for the resources in a

company and was essentially the harbinger of ERP systems to come. ERP is a

solution for the enterprise as a whole, with more functionality built in, extending

the concepts of MRP and MRP II. All the functions in an enterprise are tightly

integrated, including internal and external information. For example, an ERP

system would possess advanced functionality in the areas of financial, customer

relationship, and sales order management.

Today, the difference between MRP and ERP is that MRP can be a stand-alone

application or just a piece of an ERP, whereas ERP can support the whole

company. ERP is a single solution that addresses all business needs, not just the

scheduling of resources. ERP has moved away from its manufacturing roots and

gone on to support many different types of businesses. It decreases any

information redundancies and adds elements, like user-level security. The line

between MRP and ERP has blurred, as the more recent ERP systems rely on

similar database structures and linkages. To clarify, MRP only concentrates on

quotes, job costing, sales, orders, controlling stock, purchasing, manufacturing,

invoicing. Using an ERP system gives your company some strategic

opportunities. Companies report that the biggest benefits of their ERP system

are increased efficiency, integrated information, more customized reports,

higher-quality customer service, and more secure data. A well-used ERP system

can enable your teams to be forward-looking and support your strategic vision

for growth. A good ERP strategy improves your key business processes. 

Distribution Requirements Planning

Distribution requirements planning (DRP), also known as distribution

replenishment planning, is a continuation of MRP logic that came about in 1981.

DRP takes MRP one-step further and calculates how to move the materials out of

the facility. The product delivery is more efficient because DRP calculates the

quantity of each type of goods that requires delivery, as well as where to meet

the demand.  DRP is a time-based approach to guarantee that inventory that’s

likely to be low has a replenishment plan. DRP is similar to MRP but can work by

either a push or pull system.  ERP took over this functionality when it came

about in the 1990s. Now, DRP can still be a stand-alone system or act as a module

within an ERP system. 

Production Planning

Production planning is the process ensuring that there are sufficient raw

materials in a manufacturing business to create the products on schedule.  More

advanced than MRP, it extends the latter’s functionality. Developed to address

some of the deficiencies of MRP, production planning expands upon MRP in the

following ways:

While MRP does not assume any limitations on production, production

planning takes into account any production constraints.

Production planning prioritizes and first completes the jobs that are the

most lucrative.

Production planning considers ordered-part lead-time.

Production planning uses more complex algorithms.

PURCHASING: Purchasing is an important function of materials management. In

any industry purchase means buying of equipments, materials, tools, parts etc.

the importance of purchase function varies with nature and size of industry. The

moment a buyer places an order he commits a substantial portion of the finance

of the corporation, which affects the working capital and cash flow position. The

buyer can make or mar the company’s image by his relationship with the

vendors. The objectives of the purchasing department can be outlined as under:

To avail the materials and equipments at the minimum possible costs.

To ensure the continuous flow of production.

To increase the asset turn over.

To develop an alternative source of supply.

To establish and maintain good relation with the supplier.

Efficient record keeping and management reporting.

These objectives are in sync with the large number of well known parameters

such as right price, right quality, right contractual terms, right time, right

source, right material, right place, right mode of transportation, right

quantity and right attitude which are to be considered jointly for the purpose

of purchasing.

PURCHASING PROCEDURE: It involves following steps:

1. Determining Purchase Budget:

Purchase Manager prepares a purchase budget for the forthcoming financial

year. Purchase budget is prepared with the help of production planning

department. It contains detailed information regarding quantity to be purchased,

quality of materials, time of purchase and the sources of procurement. A

schedule of materials and components needed for various jobs, known as bill of

materials, is also prescribed for working out details of purchase budget. A bill of

materials is also useful in exercising control over the utilization of materials.

2. Receipt of Purchase Requisition:

The purchase officer initiates action for the purchase of materials only when he

receives a request for the same. The storekeeper and departmental heads send

requisition slips to purchase department giving details of materials required by

their departments etc. A purchase requisition is a form used as a formal request

to the purchasing department to purchase materials.

This form is prepared by the storekeeper for regular stock materials and by the

departmental head for specific materials not stocked as regular items. The

storekeeper knows when an action or fresh procurements is to be initiated. He

will send the requisition when materials reach re-ordering level. He retains one

copy of the requisition with him for future reference. It is on the basis of

purchase requisition that orders are placed for materials.

3. Determining Sources of Supply:

Purchase Manager remains in touch with various suppliers of materials. The

quotations are invited for the purchase of specific items. After receiving

quotations a comparative study is made regarding terms and conditions offered.

The factors to be considered include price, quantity, quality, time of delivery,

terms of payment, trade discount and reputation of suppliers. After looking at

various factors a final decision is taken about the supplier of goods.

4. Placing Order:

After selecting a supplier a formal purchase order is sent for the supply of goods.

A purchase order is sent on a printed form and is duly authorized by the

purchase manager. This order should contain details about the quantity, quality,

price, mode of delivery, terms of payment etc. The purchase order authorizes the

vendor to dispatch goods specified in it. It establishes a contractual relation

between the buyer and the vendor.

5. Follow-Up of Purchase Order:

A purchase order normally bears a date by which the goods must be delivered. It

is in the interest of the organization that goods are received in time for keeping

uninterrupted flow of materials. The suppliers may be reminded of the date of

delivery of goods. A follow-up of purchase order is necessary to receive stocks in

time.

6. Receipt and Inspection of Materials:

In big concerns the task of receiving materials is assigned to the purchase

department whereas in small concerns, the storekeeper does this work. After

unpacking goods their quantity is compared to that given in delivery challans.

Any discrepancy in items is reported to the purchase department. The

specifications and quality of goods is also checked at this stage.

7. Checking Invoices:

Lastly, purchase department checks the invoices supplied by the vendor with

that of its own records. The quantity, quality, price, terms etc. are compared with

those given in purchase order. After making full checking the invoices are sent to

accounts department for payment.

After the payment of invoices is made, purchase procedure involves maintenance

of records and maintenance of vendors.

PRICING ISSUE:

The materials stored in the stock room are issued to various jobs or production

departments against the authorized materials requisitions. The issues are

recorded in the store ledger and the respective jobs or production departments

are debited with the price of the material issued. As the time of purchase and the

time of issue are mostly different and the market price of the materials tends to

vary, the problem of pricing the materials issued necessitates certain policy

formulation. It is an important consideration not only under stores management

but also for costing and pricing policies. The fundamental consideration is

whether to price the issues at historical price i.e. the original purchase price, at

the replacement price i.e. the prevailing market price at the time of issue or at

some other price.

The various methods are used for pricing the material issues, which are based on

different principles. The important methods followed in pricing of issue of

materials are:- 1. Actual Cost Method 2. First-In First-Out (FIFO) Method 3. Last-

In First-Out (LIFO) Method 4. Highest-in First-Out (HIFO) Method 5. Simple

Average Cost Method 6. Weighted Average Cost Method 7. Periodic Average Cost

Method 8. Standard Cost Method 9. Replacement Cost Method 10. Next in First

Out (NIFO) Method 11. Base Stock Method.

1. Actual Cost Method:

Where materials are purchased specially for a specific job, actual cost of

materials is charged to that job. Such materials will normally be stored

separately and issued only to that particular job.

2. First-In First-Out (FIFO) Method:

CIMA defines FIFO as “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.

Example: the following transactions occurred during the first week of April,

2019:

April 1: 200 units purchased @ Rs 5 per unit

April 3: 500 units purchased @ Rs 6 per unit

April 5: 300 units issued to job No. 1001

The issue of 300 units will be priced as under

From the first lot: 200 units @ Rs 5 = 1000

Remaining 100 units from second lot = 100 units @ Rs 6 = 600

1,600

The value of the closing stock of 400 units (i.e. second lot 500 units less 100 units

issued) will be costed @ Rs 6 i.e. the value of closing stock would be Rs 2,400.

Advantages:

(a) It is easy to understand and simple to price the issues.

(b) It is a good store keeping practice which ensures that raw material leave the

stores in a chronological order based on their age.

(c) It is a straight forward method which involves less clerical cost than other

methods of pricing.

(d) This method of inventory valuation is acceptable under standard accounting

practice.

(e) It is a consistent and realistic practice in valuation of inventory and finished

stock.

(f) The inventory is valued at the most recent market prices and it is near to the

valuation based on replacement cost.

Disadvantages:

(a) 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.

(b) If the price of the materials purchased fluctuates considerably, it involves

more clerical work and there is possibility of errors.

(c) In a situation of rising prices, production cost is understated.

(d) In inflationary market, there is a tendency to under-price material issues. In

deflationary market, there is a tendency to overprice such issues.

(e) Usually more than one price has to be adopted for a single issue of materials.

(f) The method makes cost comparison difficult of different jobs when they are

charged with varying prices for the same materials.

This method is more suitable where the size of the raw materials is large and

bulky and its price is high and can be easily identified in the stores separately.

This method is useful when the frequency of material receipts is less and the

market price of the material is stable and steady.

3. Last-In First-Out (LIFO) Method:

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.

Example: the following transactions occurred in the stores department during

the first week of April, 2019

April 1: 500 units purchased @ Rs 5

April 3: 300 units purchased @ Rs 6

April 6: 400 units issued to Job Order No. 1086

The issue of 400 units on April 6, will be priced as under:

First 300 units @ Rs 6 = Rs 1,800

Remaining 100 units @ Rs 5 = Rs 500

Rs 2,300

The closing stock of 400 units will be priced @ Rs 5 i.e. Rs 2,000

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 by valuation of inventory at value before price rise and provides a

hedge against inflation.

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.

4. Highest-in First-Out (HIFO) Method:

Under this method, the materials with highest prices are issued first, irrespective

of the date upon which they were purchased. The basic assumption is that in

fluctuating and inflationary market, the cost of material are quickly absorbed

into product cost to hedge against risk of inflation. This method is used when the

material is in short supply and in execution of cost plus contracts. This method is

not popular and not acceptable under standard accounting practices.

5. 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. For example, three batches of

materials received at Rs. 10, Rs. 12 and Rs. 14 per unit respectively.

The simple average price is calculated as follows:

Rs. 10 + Rs. 12 + Rs. 14/3 batches = Rs. 36/3 batches = Rs 12 per unit

This method is not popular because it takes into consideration the prices of

different batches but not the quantities purchased in different batches. This

method is used when prices do not fluctuate very much and the stock values are

small in value.

6. 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. For example, three

batches of material received in quantities of 1,000 units @ Rs. 15, 1,300 units @

Rs. 16 and 800 units @ Rs. 14.

The weighted average price is calculated as follows:

(1,000 units x Rs. 15) + (1,300 units x Rs. 16) + (800 units x Rs. 14)/1,000 units +

1,300 units + 800 units

= Rs. 15,000 + Rs. 20,800 + Rs. 11,200/3,100 units = Rs. 47,000/3,100 units = Rs.

15.16 per unit

This method tends to smooth out the fluctuations in price and reduces the

number of calculations to be made, as each issue is charged at the same price

until a fresh batch of material is received.

This method is easier as compared to FIFO and LIFO, as there is no necessity to

identify each batch separately. But this method increases the clerical work in

calculation of new average price every time a new batch is received. The issue

price calculated rarely represents the actual purchase price.

7. Periodic Average Cost Method:

Under this method, instead or recalculating the simple or weighted average cost

every time there is a receipt, an average for the accounting period as a whole is

computed.

The average price for all the materials issued during the period is computed as

follows:

8. Standard Cost Method:

Under this method, material issues are priced at a predetermined standard issue

price. Any variance between the actual purchase price and standard issue price is

written off to the Profit and Loss Account. Standard cost is a predetermined cost

set by the management prior to the actual material costs being known and the

standard issue price is used for all issues to production and for valuation of

closing stock.

If initially the standard price is set carefully then it reduces all the clerical work

and errors tremendously and the stock recording procedure is simplified. The

realistic production cost comparisons can be made easier by eliminating

fluctuations in cost due to material price variance. In a situation of fluctuating

prices, this method is not suitable.

9. Replacement Cost Method:

This method is also called as ‘market price method’. The replacement cost is a

cost at which material identical to that can be replaced by purchasing at the date

of pricing material issues; as distinct from the actual cost price at the date of

purchase. The replacement price is the price of replacing the material at the time

of issue of materials or on the date of valuation of closing stock.

This method is not acceptable for standard accounting practice, since it reflects a

cost which has not really been paid. If stocks are held at replacement cost, for

balance sheet purposes when they have been bought at a lower price, an element

of profit which has not yet been realized will be built into the Profit and Loss

Account.

This method is advocated by charging the market price of material to the job or

process, make it easier to determine the profitability of the job or process. This

method is suitable particularly in the inflationary tendency of market prices of

materials. Where there is no precise market for particular materials, it would be

difficult in ascertainments of replacement prices for the material issues.

10. Next in First Out (NIFO) Method:

This method is a variant of replacement cost method. Under this method the

price quoted on the latest purchase order or contract is used for all issues until a

new order is placed.

11. Base Stock Method:

Under this method, a specified quantity of material is always held in stock and is

priced at its original cost as buffer or base stock; and any issue of materials

above the base stock quantity is priced under any one of the methods discussed

above.

This method indicates how prices are moving over a longer period of time. But

this method is not popular and also not accepted under standard accounting

practice since it would result in stock valuation totally unrealistic.

MATERIAL STORING AND ISSUE

A proper system of Inventory Control together with scientific methods of store

keeping will make inventory management most effective. This is the function,

which is much more concerned directly with inventory management as

compared to other functions. Store is the safe custody of all the items of

materials stocked in the storeroom for which the storekeeper acts as a trustee or

custodian. The most important function performed by stores is to provide

uninterrupted service to manufacturing and marketing divisions. Store Keeping

is a function of receiving, storing and issuing of materials. It involves supervision,

safety and readiness of materials for use and issuing them against requisitions.

Stores Management is concerned with carrying right type of materials in right

quantity, provisioning materials quickly as and when required, keeping itself

against any kind of deterioration, theft and to carry out efficient performance of

all these functions at the lowest possible cost.

Stores Issue Procedure: The user department will logically judge the efficiency

of stores department by provision of services of high standard rendered by the

stores department Inventory management fundamentals also emphasis this

aspect. In order to prevent indiscriminate issue, consequently wastage and

improper use of goods the issues must be properly authorized, either in written

or verbal form if it is a routine arrangement. The following points should be

considered for issue procedures:

Authorization of issue - Against written/signed document or verbal

instruction as per the policy

Validity of demand - Items to be issued for the job/purpose it is meant

Identification of requirement - Required items must be identified through

code numbers

Timing of issue - To ensure timely issue, requisition must flow in time

Storing Policies:

Policies Relating to Organization: Generally, stores department is headed by store

keeper or stores manager in an organization. But, depending upon the location of

stores and policy of centralization or decentralization the stores organization

may be as under:

1. Centralized stores: Centralization of store keeping is concerned with the

placement of an authority with the store keeper or stores manager as the

case may be. It is least concerned with the location of the storekeeper

even though it may be an important consideration. Centralization takes

place when the entire store keeping function is made the responsibility of

single person, who is held accountable by the top management for proper

performance.

2. Decentralized Stores: Decentralization of stores occurs when personnel

from other functional areas or other departments viz. production,

engineering besides stores department perform the function of stores.

Policies Relating to Stores system and categories:

a. Open Access Storage System: This is widely used in highly repetitive mass

production types of organization, which shows a continuous and

predictable demand for materials. Under this system, no store room exists

as such and normally material is physically stored nearest to the point of

it’s use just as it is stored in the store room. Materials are stored in bins,

racks, shelves, pallets, in boxes etc. Storage facilities are open and an

employee has open access to any storage facility.

b. Closed Storage System: Materials are stored in closed and controlled store

area. Usually the storage area is kept locked for physical control purpose.

All the receipts and issues are made with authentic documents only.

Maximum physical security and tighter accounting control is ensured

through this system. No one except the stores personnel is permitted to

withdraw materials from stores.

c. Random Access Storage System: This is a unique storage system where

materials are stored at random locations in the stores. Whenever materials

are received, they are stored in available shelf. On the issue of any stores

items, the space available is used for any other materials coming in the

stores. Usually records for stores are computerized to know the locations.

Nonetheless, effects are made to groups of similar types and sizes of

storage equipments, which may facilitate division of stores as per the

storage requirements of different items. Whenever punched record card is

prepared for records purpose, location address is written on the card. This

system suffers from following drawbacks:

• It is very expensive

• Physical control becomes difficult

• Creates problems when record card is lost

d. Stores at supplier’s plant: From the discussion of the above systems, it is

clear that each one has it’s own limitations. Therefore, practically

combination of any two or more may be used in any particular organization.

Policies Relating to Methods and Practices of Issue:

Before discussing various methods of issue it is advisable to understand the

following different issue systems:

a. Issue on Demand System: In this system material is issued against

material requisition note prepared by competent authority.

Sometimes, stores in-charge may be required to check the papers

prepared at works planning stage or the work order papers.

b. Trolley Delivery System: In this system a trolley is routed to

various user departments at a regular interval of time. Foremen

are asked to withdraw the goods from the trolley according to

their need, surely against the withdrawal slip.

c. Open Access Bin System: For regular items, open access bin are

kept in the user departments. This bin is replenished from time to

time. User department can withdraw the goods from the open

access bins without undergoing any formal procedure.

Various methods of issue are as under:

Issue on Request: This method again, can be used in the following three

different manners

I. Immediate issues on presentation of M.R. note

II. Issue made after the receipt of M.R. note

III. Immediate issues on verbal request only

Scheduled issue to production: In mass production factories, production

materials are issued in quantities and at times to correspond with the

manufacturing programme. In this case issue schedule is prepared and

stores department has to issue the materials accordingly under any of the

systems discussed above.

Assemblies and Kits: In certain instances, composite issues of a standard

nature are required. An assembly of a given item might consist standard

items in standard number. In this case, instead of preparing different

Materials Requisition Notes, a single note must serve the purpose.

Similarly, tools or gauges for special jobs may be issued in complete kits.

Imprest Issue: An imprest system is one whereby sub-stores of

production department are allowed to carry certain items in given

quantities. At the end of the given period the user concerned prepares a

list of materials to be consumed during that time and present an

appropriate issue document for replenishment of goods to bring back the

imprest stock up to the same level as it was at the beginning of the period.

Replenishment Issue: Certain items like tools etc. may be issued against

the used articles or empty containers. This is called as a replenishment

issue.

Loan Issue: Tools or certain equipments may be given to user

departments on loan, i.e. on returnable basis. For such issues, a register

may be maintained, or instead of that, such items may be given in

exchange of tallies provided to the workmen.

Also there can be other issues made outside the organization. When

finished goods have to be dispatched, it must be done against issue order

or sales advice note or similar documents from sales department.