Direct and Indirect Materials
The purpose of this article is to develop an understanding of how cost accountants deal
with stocks, how they are valued and most importantly, how they are controlled.
Remember that costs may either be an expense, which would be written off in the profit
and loss account, or a cost may be an asset, which would be carried forward in the
balance sheet. This is due to the application of the accruals concept. It is therefore
necessary to classify costs in the most appropriate manner, so that they are valued,
accounted for, and controlled as efficiently as possible.
As such, this article would answer the following questions:
1. How are items of stock, such as materials, controlled within a cost accounting
2. What are the reasons for holding stock and what are the limitations of doing so?
3. What are the appropriate methods of establishing reorder levels whilst
minimizing the cost of holding stock trough the interpretation of optimal reorder
How are items of stock, such as materials, controlled within a cost accounting system?
1. Stocks are controlled using what is known as a stock control system. This
system should cover the following functions:
a) The ordering of stock
b) The purchase of stock
c) The receipt of goods into store
e) The issue of stock and maintenance of stock at the most appropriate level.
The reasons are due to the following points:
a) Holding costs of stock may be expensive
b) Production will be disrupted if we run out of raw materials
c) Unused stock with a short shelf life may incur unnecessary expenses.
2. Furthermore, proper records must be kept regarding the ordering, receipt and
issue of stock using the following process:
a) When stocks reach the reorder level, the stores department issues a purchase
requisition to the purchase department to order further stock.
b) The purchase department then issues a purchase order to the supplier
c) Once the stock is delivered, the storekeeper signs a delivery note. The stocks
are then further inspected for deficiencies. If all is okay, the store keeper prepares a
goods received note (GRN) to the accounts department that check it with the purchase
order. The supplier is paid.
The reasons are to ensure that:
a) Enough stock is held
b) There is no duplication of ordering
c) Quality is maintained
d) There is adequate record keeping for accounts purposes. 3. Storage of Raw Materials; Storekeeping involves storing materials to achieve the
a) Speedy issue and receipt of materials
b) Full identification of all materials at all times
c) Correct location of all materials at all times
d) Protection of materials
e) Efficient use of storage space
f) Maintenance of correct stock levels
g) Keeping up to date records
This is done through the use of:
a) Bin Cards – kept with the actual stock and updated whenever items are issued
b) Stores Ledger Accounts
c) Stock Codes – materials held in stores are coded and classified
4. Stocktaking – this process involves counting the physical stock on hand at a
certain date and matching it with the balance shown in the stock records. This process
should enable us to avoid discrepancies, check our records, and make sure that we
know the free stock balance, which is actual stock that is available for future use.
Stocktaking may be periodic or continuous, in which the later involves using a perpetual
• Materials in stock plus Order from Suppliers less materials requisitioned equals
free stock balance.
5. An Order Cycling Method may be used, where quantities on hand of each stores
item are reviewed periodically.
6. A Two-bin system may also be used whereby each stores item is kept in two
storage bins. When the first bin is emptied, an order must be placed for re-supply.
7. Materials may be classified as expensive, inexpensive or middle-cost range.
Whilst the last two items are stored in large quantities, the expense items are subject to
careful stores control procedures.
8. Computerization, whereby stock masters file is maintained concerning all the
transactions and details of stock movement. This will ensure the following:
a) Easier process
b) Better maintenance of records
c) Backup copies could be made.
What are the reasons for holding stock and what are the limitations of doing so?
The main reasons for holding stock are:
1. To ensure that sufficient goods are available to meet expected demand.
2. To provide a buffer between process (in cases where output stock is the input
stock for another process.
3. To meet any future shortages
4. To take advantage of any bulk purchasing discounts 5. To absorb seasonal fluctuations and any variations in usage and demand.
6. To allow production process to flow smoothly and efficiently.
7. Holding stock is necessary due to fermentation, e.g. wine.
8. As a deliberate investme