UNIT - 1 ( ACA)

 5Q. Methods of inventory control

6Q. Classification of Labour

7Q. Methods of Remuneration

8Q. Overheads

5Q. Methods of inventory control

          Material control aims at eliminating and minimizing all kinds of wastes and losses while the materials are being purchased, stored, handled, issued/ consumed. A number of techniques are used in planning, procuring, and holding stages of material which help in exercising and effecting material cost control.

Methods:

1. Just in time

2. stock turnover

3. perpetual inventory

4. periodic inventory

5. ABC analysis

6. economic order quantity( EOQ)

1. Just in time: JIT is a system of inventory management with an approach to having zero inventories in stores. According to this approach, the material should only be purchased when it is actually required for production.

 JIT is based on two principles 

(i) Produce goods only when it is required and 

(ii) the products should be delivered to customers at the time only when they want. 

        It is also known as the ‘Demand pull’ or ‘Pull through’ system of production. In this system, the production process actually starts after the order for the products is received. Based on the demand, the production process starts and the requirement for raw materials is sent to the purchasing department for purchase.

Advantages:  

• investment in inventory is reduced because more frequent purchase orders of small quantities are made
• carrying cost is reduced as a result of low investment in inventory
• it helps to develop a long run relationship with the suppliers
• quality costs such as inspection cost of receiving materials/ goods and scraps are reduced because just-in-time purchasing assures quick and frequent deliveries of small-size orders which results in a low level of inventory causing minimum possible wastage.

Disadvantages: 

•  a supplier that doesn't deliver goods to the company exactly on time and in the correct amounts could seriously impact the production process
• a company may not be able to immediately meet the requirements of a massive and unexpected order, since it has few / no stocks of finished goods.

2. Stock turnover: It is important to evaluate the efficiency and effectiveness of inventory management of the firm. The ratio indicates how many times inventory is sold and replaced in a financial year. it has been stated earlier that to minimize the amount of investment, raw materials stock may be classified into fast-moving items and slow-moving items.

(i) Fast Moving- This category of items is placed nearer to the store issue point and the stock is reviewed frequently for making fresh orders. 

(ii) Slow Moving- This category of items is stored a little far and stock is reviewed periodically for any obsolescence. and maybe shifted to the Non-moving category. 

(iii) Non-Moving- This category of items is kept for disposal. This category of items is reported to the management and an appropriate provision for loss may be created. 

Some of the reasons for slow-moving and non-moving inventories are stated below: 

(i) Failure of production management to communicate the updated requirement to the store's management

 (ii) Technological upgradation in terms of new machines requiring new kinds of material or existing material becoming obsolete. 

(iii) Lack of periodic review of inventories. 

    By careful observation, timely identification, and adoption of inventory management techniques such as maintenance of minimum level or just-in-time approach, one can manage slow-moving and non-moving inventories. We may calculate the inventory turnover ratio and present the reports of comparison of actual and standards with variations if any to the management.

Inventory Turnover Ratio = Cost of average held stock during the period / Cost of materials consumed during the period

 Average stock = 1/2 (opening stock + closing stock) 

Average no. of days of Inventory holding = 365days /12months Inventory TurnoverRatio

3. Perpetual inventory records and continuous stock verification: Perpetual inventory represents a system of records maintained by the store's department. It, in fact, comprises (i) Bin Cards, and (ii) Stores Ledger.

Bin Cards: It is a quantitative record of inventory that shows the quantity of inventory available in a particular bin. Bin refers to a box/ container/ space where materials are kept. A card is placed with each bin (space) to record the details of material like a receipt, issue, and return. It is maintained by the store department. 

Stock ledger: It is also a quantitative record of inventory maintained by the stores department for every item of material. In other words, it is a record that shows the overall inventory position in the store. The recording includes receipt, issue, return, in hand, and order given.

The success of perpetual inventory depends upon the following: 

(a) The Stores Ledgershowing quantities and amount of each item. 

(b) Stock Control cards (or Bin Cards).

 (c) Reconciling the quantity balances shown by (a) & (b) above.

 (d) Checking the physical balances of a number of items every day systematically and by rotation. 

(e) Explaining promptly the causes of discrepancies, if any, between physical balances and the book figures.

 (f) Making corrective entries wherever required after step (e) and 

(g) Removing the causes of the discrepancies referred to in step (e)

 Advantages of perpetual inventory:

 The main advantages of perpetual inventory are as follows:

 (1) Physical stocks can be counted and book balances adjusted as and when desired without waiting for the entire stock-taking to be done. 

(2) Quick compilation of Profit and Loss Account (for the interim period) due to prompt availability of stock figures. 

(3) Discrepancies are easily located and thus corrective action can be promptly taken to avoid their recurrence.

(4) A systematic review of the perpetual inventory reveals the existence of surplus, dormant, obsolete, and slow-moving materials, so that remedial measures may be taken in time. 

(5) Fixation of the various stock levels and checking of actual balances in hand with these levels assist the storekeeper in maintaining stocks within limits and in initiating purchase requisitions for the correct quantity at the appropriate time. 

Continuous Stock Verification: The checking of physical inventory is an essential feature of every sound system of material control. The system of continuous stock-taking consists of physical verification of items of inventory. The stock verification may be done by the internal audit department but are independent of the store and production staff. Stock verification is done at an appropriate interval of time without prior notice. The element of surprise is essential for effective control of the system. 

4. periodic inventory: A periodic Inventory System is defined as an inventory valuation method in which inventories are physically counted at the end of a specific period to determine the cost of goods sold.

• That means the ending inventory balance is updated only at the end of the period instead of a perpetual inventory system where inventories are counted frequently.
• The “Generally Accepted Accounting Principle” allows firms to accept any model.
• The periodic system can be used in small and retail businesses where the inventory quantity is generally high, but the value is on the lower side. This way, businesses can save time and resources.

5. ABC Analysis: This system exercises discriminating control over different items of inventory on the basis of the investment involved. Usually, the items are classified into three categories according to their relative importance, namely, their value and frequency of replenishment during a period.

 (i) ‘A’ Category: This category of items consists of only a small percentage i.e., about 10% of the total items handled by the stores but require heavy investment about 70% of inventory value, because of their high prices or heavy requirement or both. Items under this category can be controlled effectively by using a regular system that ensures neither over-stocking nor a shortage of materials for production. Such a system plans its total material requirements by making budgets. The stocks of materials are controlled by fixing certain levels like maximum level, minimum level, and re-order level.

 (ii) ‘B’ Category: This category of items is relatively less important; they may be 20% of the total items of material handled by stores. The percentage of investment required is about 20% of the total investment in inventories. In the case of these items, as the sum involved is moderate, the same degree of control as applied in the ‘A’ category of items is not warranted. The orders for the items, belonging to this category may be placed after reviewing their situation periodically. 

(iii) ‘C’ Category: This category of items does not require much investment; it may be about 10% of the total inventory value but they are nearly 70% of the total items handled by the store. For this category of items, there is no need of exercising constant control. Orders for items in this group may be placed either after six months or once a year, after ascertaining consumption requirements. In this case, the objective is to economies on ordering and handling costs. 

6. Economic Order Quantity (EOQ): The size of an order for which the total ordering and carrying costs are minimum. 

Ordering Cost: Ordering costs are the costs that are associated with the purchase or order of materials such as the cost to invite quotations, documentation works like preparation of purchase orders, employee costs directly attributable to the procurement of material, transportation, and inspection cost, etc. 

Carrying Cost: Carrying costs are the costs for holding/ carrying inventories in store such as the cost of funds invested in inventories, cost of storage, insurance cost, obsolescence, etc.

 The Economic Order Quantity (EOQ) is calculated as below:

Annual Requirement (A)- It represents the demand for raw material or Input for a year.

 Cost per Order (O) - It represents the cost of placing an order for purchase. 

Carrying Cost (C) – It represents the cost of carrying average inventory on annual basis. 

Assumptions underlying E.O.Q.: The calculation of the economic order of material to be purchased is subject to the following assumptions: 

(i) Ordering cost per order and carrying cost per unit per annum are known and they are fixed. (ii) Anticipated usage of material in units is known. 

(iii) Cost per unit of the material is constant and is known as well.

 (iv) The quantity of material ordered is received immediately i.e. the lead time is zero

6Q. Classification of Labour( Employee) cost: Benefits paid or payable to the employees of an entity, whether permanent or temporary for the services rendered by them. Employee cost includes payments made in cash or kind. Employee cost includes the following: 

(i) Wages and salary; 

(ii) Allowances and incentives; 

(iii) Payment for overtime; 

(iv) Employer’s contribution to Provident fund and other welfare funds; 

(v) Other benefits (leave with pay, free or subsidised food, leave travel concession etc.) etc. 

Classification of Employee (Labour) cost: Employee costs are broadly classified as direct and indirect employee costs. 

(i) Direct Employee (Labour) Cost Benefits paid or payable to the employees which can be attributed to a cost object in an economically feasible manner. This can be easily identified and allocated to an activity, contract, cost centre, customer, process, product etc. 

(ii) Indirect Employee (Labour) Cost Benefits paid or payable to the employees, which cannot be directly attributable to a particular cost object in an economically feasible manner.

EMPLOYEE (LABOUR) COST CONTROL Employee costs are associated with human beings. To control employee costs one has to understand human behaviour. Employee cost control means control over the cost incurred by employees. Control over employee costs does not imply control over the size of the wage bill; it also does not imply that the wages of each employee should be kept as low as possible. 

      The aim should be to keep the wages per unit of output as low as possible. This can only be achieved by giving employees appropriate compensation to encourage efficiency so that optimum output can be achieved in an effective manner. 

A well-motivated team of employees can bring about wonders. Each concern should, therefore, constantly strive to raise the productivity of employees. The efforts for the control of employee costs should begin from the very beginning. There has to be a concerted effort by all the concerned departments.  

Accounting for labour cost: The main points which need consideration for controlling employee costs are the following:

1. timekeeping

2. time booking

3. idle time

4. overtime

5. labour turnover

6. remuneration system

1. Timekeeping: Timekeeping is the recording of each worker's time of coming in and going out of the factory for the purpose of attendance and determination of wage payable to each worker. 

Methods of Time-keeping: There are various methods of time-keeping, which may be categorized into manual and mechanical methods. The choice of a particular method depends upon the requirements and policy of an entity; but whichever method is followed, it should make a correct record of the time by incurring the minimum possible expenditure and it should minimise the risk of fraudulent payments of wages. The examples of timekeeping methods are as follows:

1. Manual Methods

 (a) Attendance Register method- Under this method, an attendance register is kept to record the arrival and departure times of an employee. This method is simple and expensive and is suitable for small organisations. However, this method may lead to the dishonest practice of time manipulation by way of recording the wrong time and back date entries in collusion with the timekeeper.

 (b) Metal Disc/ Token method- This method of time recording is very old and is almost obsolete in practice. Under this method, each employee is allotted a metal disc or a token with a hole bearing his identification number. The token is kept or handed to the timekeeper who records the token number in his register. Like the attendance register method, this method also has some disadvantages like errors in recording, proxy attendance etc. 

2. Mechanical/ Automated Methods

 (a) Punch Card Attendance- Under this method, each employee is provided with a card for marking attendance. A punch card contains data related to the employee in digital form. In the punch card attendance system, an employee needs to either insert or wave his card to a card reader which then ensures whether the correct person is logging in and/or out. This system does not require to employ of any timekeeper and minimises the risk of recording errors and time manipulation.

 (b) Bio-Metric Attendance system- Under the bio-metric attendance system attendance is marked by recognizing an employee on the basis of physical and behavioural traits. An employee’s unique identity like fingerprint, face and retina image etc. is kept in a database which is matched at the time of marking of attendance before the attendance device for this purpose. Bio-metric attendance system includes fingerprint recognition system, face recognition system, Time and attendance tracking technology etc. This system reduces the risk of time manipulation and proxy attendance. However, it may not be suitable for small organisations due to the cost associated with set-up and maintenance.

2. Time booking: Time booking refers to a method wherein each activity of an employee is recorded. This data recorded is further used to measure the time spent on a particular job for costing, measurement of efficiency, fixation of responsibility etc.

Payroll Procedure:

 The steps included in this process are as under:

1. Attendance and Time details: A detailed sheet of the number of days or hours worked by each employee (in case of time-based payment) and units or percentage of work (in case of piece rate) as reflected by the timekeeping methods are sent to the payroll department by the timekeeping department. Further, the payroll department with the help of time booking records calculates any further incentives such as overtime pay, and bonuses to be paid to the employees.

 2. List of employees and other details: A list of employees on a roll and the rate at which they will be paid is sent by the personnel/ HR department. The payroll department should ensure that no unauthorised or bogus employee is paid.

 3. Computation of wages and other incentives: The payroll department based on the details provided by the timekeeping department and personnel department calculates wages/ salary to be paid to the employees. The payroll department prepares to pay slips for all employees authorized by the personnel department and forwards the same to the cost/ accounting department for further deductions and payment.

 4. Payment to the employees: The cost/ accounting department deduct all statutory deduction such as employee contribution to provident fund and employee state insurance (ESI) scheme, TDS on salary etc. After all deductions wages/ salary is paid to the employees. 

5. Deposit of all statutory liabilities: All statutory deductions made from wages/ salary of the employees along with employer’s contributions such as provident fund and employee state insurance scheme are paid to the respective statutory bodies. 

3. Idle time: The time during which no production is carried-out because the worker remains idle but is paid. In other words, it is the difference between the time paid and the time booked. Idle time can be normal or abnormal. The time for which employees are paid includes holidays, paid leaves, allowable rest or off time etc. 

Normal idle time: It is the time which cannot be avoided or reduced in the normal course of business.

Causes 

1. The time lost between the factory gate and the place of work, 

2. The interval between one job and another,

 3. setting up a time for the machine,

 4. Normal rest time, break for lunch etc.

Treatment

 It is treated as a part of the cost of production. Thus, in the case of direct workers, an allowance for normal idle time is considered a set of standard hours or standard rates. In the case of indirect workers, normal idle time is considered for the computation of the overhead rate.

Abnormal idle time: Apart from normal idle time, there may be factors which give rise to abnormal idle time. 

Causes

1. Idle time may also arise due to abnormal factors like a lack of coordination 

2. Power failure, Breakdown of machines  

3. Non-availability of raw materials, strikes, lockouts, poor supervision, fire, flood etc.

 4. The causes for abnormal idle time should be further analysed into controllable and uncontrollable.

 i) Controllable abnormal idle time refers to that time which could have been put to productive use had the management been more alert and efficient. All such time which could have been avoided is controllable idle time. 

ii) Uncontrollable abnormal idle time refers to time lost due to abnormal causes, over which management does not have any control e.g., breakdown of machines, flood etc. may be characterised as uncontrollable idle time

Treatment

The abnormal idle time cost is not included as a part of the production cost and is shown as a separate item in the Costing Profit and Loss Account. The cost of abnormal idle time should be further categorised into controllable and uncontrollable. For each category, the break-up of cost due to various factors should be separately shown. This would help the management in fixing responsibility for controlling idle time. Management should aim at eliminating controllable idle time and on a long-term basis reducing even the normal idle time. This would require a detailed analysis of the causes leading to such idle time.

4. Overtime: Work done beyond normal working hours is known as ‘overtime work’. Overtime payment is the amount of wages paid for working beyond normal working hours. Overtime payment consists of two elements- (i) Normal wages for overtime work and (ii) Premium payment for overtime work.

Overtime Payment = Wages paid for overtime at normal rate + Premium (extra) payment for overtime work

Overtime premium: The rate for overtime work is higher than the normal time rate; usually it is double the normal rate. The extra amount so paid over the normal rate is called an overtime premium. 

Rate and conditions for overtime premium may either be fixed by an entity itself or may be required by any statute in force. The overtime premium should not be less than the premium calculated as per the statute.

 As per the Factories Act 1948 “Where a worker works in a factory for more than nine hours in any day or for more than fourty-eight hours in any week, he shall, in respect of overtime work, be entitled to wages at the rate of twice his ordinary rate of wages.” 

 Causes:

(1) The customer may agree to bear the entire charge of overtime because of the urgency of work. 

 (2) Overtime may be called for to make up any shortfall in production due to some unexpected development. 

 (3) Overtime work may be necessary to make up a shortfall in production due to some fault of management. 

(4) Overtime work may be resorted to, to secure an out-turn in excess of the normal output to take advantage of an expanding market or of rising demand 

Treatment:

(1) If overtime is resorted to at the desire of the customer, then overtime premium may be charged to the job directly.

(2) If overtime is required to cope with general production programmes or for meeting urgent orders, the overtime premium should be treated as an overhead cost of the particular department or cost centre which works overtime.

(3) If overtime is worked in a department due to the fault of another department, the overtime premium should be charged to the latter department

(4) Overtime worked on account of abnormal conditions such as flood, earthquake etc., should not be charged to cost, but to Costing Profit and Loss Account.

5. labour turnover: Labour turnover denotes the percentage change in the labour force of an organisation. A high percentage of labour turnover denotes that labour is not stable and there are frequent changes in the labour force because of new workers engaged and workers who have left the organisation. A high labour turnover is not desirable.

The definitions of labour turnover are given below:

(1) Labour turnover according to separation method:

This definition does not take into consideration the fact of surplus labour. This definition will give incorrect results when the surplus workers are discharged because labour turnover calculated in this way will be high.

(2) Labour turnover according to the flux method:

This definition will not be applicable when the organisation is expanding. In such a case, many new workers are engaged and there may be no separation; even then labour turnover calculated will be high.

This definition will misguide when an organisation has reached its optimum size and does not require expansion at all. In such a case, labour turnover, as per this definition, will show half the actual percentage of labour turnover.

(4) Labour turnover according to replacement method:

This definition takes into account surplus labour. This definition will also give correct labour turnover when the factory is expanding because all additions are not to be taken only workers replaced due to leavers are to be taken. Therefore, this definition can be taken to be the most reliable definition out of all the definitions given above.