Prepared y SM Nahidul Islam 1

Dept. of Finance & Banking

1. Definition of Materials

Answer: Materials are the basic substances used in the process of production. These substances are
transformed into finished goods in the course of production. Raw cotton, wool, silk, oil seeds, sugarcane,
leather, steel, rubber, timber etc. are some examples of raw materials which are converted into finished
products. It can be direct as well as indirect.

a. Direct Material: Direct materials are the materials that can be specifically identified with the
product.
b. Indirect Material: Indirect materials costs are usually variable because materials are based on the
level of production.

2. State the levels of stock

Answer: In stores records, different levels of stock are mentioned. The levels are given below:
1. Minimum level: Minimum level is that level of stock below which the stock must not go at any time.
Minimum stock level = Reordering level (Normal consumption Normal reorder period)
This level is fixed after considering the following factors:
a. Nature of the material: Materials that are regularly stored must maintain a minimum level.
b. Lead time: Lead time is the maximum time required from the date of order to the date of actual
delivery.
c. Rate of consumption of the material: The minimum rate, the maximum rate and the normal rate of
consumption are to e taken into consideration.
2. Maximum Stock Level: The maximum stock level is that level of stock above which the stock must
not go at any time.
Maximum stock level = Reorder level + Reordering quantity (Minimum consumption Minimum
delivery period)
The maximum stock level is fixed by taking into consideration the following factors:--
a. Minimum rates of consumption.
b. The lead time.
c. Economic ordering quantity.
d. Availability of funds,
e. Availability of storage space.
f. Risk of obsolescence, depletion, evaporation and material waste,
g. Future fluctuations of price of materials.
h. Cost of storage and insurance.
i. The nature of material--seasonal supplies etc.
j. Any restrictions imposed by the government or restrictions in respect of import of materials.

3. Ordering or Re-ordering level: This level is fixed between the minimum level and the maximum
level. This is fixed in such a manner that the excess of ordering level over the minimum level is
sufficient to meet the requirement during the lead time.
Reorder level = Maximum consumption Maximum reorder period

Islamic University, Kushtia

 Prepared y SM Nahidul Islam 2
Dept. of Finance & Banking

Following are the factors that are taken into account for fixing re-order level.
a. The maximum consumption.
b. Lead time.
c. Economic order quantity.
4. Danger level: The danger level is below the minimum level and represents a stage where immediate
steps are taken for getting replenished. The danger level is fixed y considering the following factors:

a. Average Consumption.
b. Emergency Lead Time.

3. Definition of overhead & State the classification of overhead

Answer: Any expenditure which cannot be charged directly to any job, operation, or process may be called
overhead. Thus, overhead indicates indirect expenditure of any kind. It includes materials, indirect wages
and indirect expenses.
According to Kohler, Overhead may be defined as any cost of doing business other than a direct cost of an
output of product or service.

Overhead cost may be classified according to:

a. Function
b. Elements
c. Behavior
A. Function wise classification: It includes the followings
1. Production overheads: All costs incurred in the factory over and above direct material cast,
direct labour and direct expenses are known as Production Overheads.
2. Administration overheads: It refers to cost of management, and of secretarial, accounting and
administrative services, which cannot be directly related to the production, marketing, research or
development functions of the enterprise.
3. Selling and distribution overheads: Selling and distribution overheads include all such
expenses which are incurred on functions like selling, advertising, transportation, warehousing
etc.
B. Element wise classification: Under this method, overheads are broken down into the following
elements:
1. Indirect material: Consumable stores, fuel, lubricating oil, cotton waste, small tools for general
use, loss, deficiencies and deterioration of stores etc.
2. Indirect labour: Salary of the foreman, supervisory staff and works manager, wages for
maintenance workers, payment for overtime premium hours, workmens compensation,
Employers contribution to provident fund etc.
3. Indirect expenses: Repairs and maintenance to plant and machinery, factory rent, depreciation of
plant and machinery, expenses on keeping and handling stores, rent, rates and taxes, insurance,
training expenses, canteen expenses etc.
C. Behaviour wise classification: Under this method, overheads are broken down into the following
kinds:
1. Variable overheads: It includes indirect material, indirect labour, power and fuel, salesmens
commission, etc.
Islamic University, Kushtia
 Prepared y SM Nahidul Islam 3
Dept. of Finance & Banking

2. Fixed overheads: It includes rent and rates, insurance, depreciation of machinery and buildings,
office expenses, legal expense, bank charges, interest on capital etc.
3. Semi-variable overhead: They represent partly variable and partly fixed overheads. Examples
are repairs and maintenance, depreciation of plant and machinery, salary payable to a supervisor,
telephone expenses.

4. Definition of Economic Order Quantity (EOQ)

Answer: Economic order quantity (EOQ) is a level of inventory where the total cost of holding inventory is
at minimum. Economic order quantity is the level of quantity at which the cost of ordering will be equal with
the storage cost of materials. While determining the economic order quantity, the following costs should be
considered.
a. Ordering Cost: It includes Cost of stationary purchases, telephone charge, email charge, fax charge
etc.
b. Carrying Cost: It includes Cost of storage, Insurance cost of materials, Cost of maintaining the
materials to avoid deterioration etc.
We can calculate EOQ by using the given formula:

EOQ =

Where,
A = Consuption per annum in units.
O = Order cost for placing one order
C = Carrying cost of one unit for one year.

Describe First in First out Method (FIFO) & Last in First out Method (LIFO)

First in First out (FIFO): FIFO is one of the most popular methods of calculating the actual cost of material
issues, and the value of closing inventory. Under this method, the first item received should be the first item
to be issued. Advantages of FIFO are given below:
1. Charge to production is the actual cost of materials;
2. Issue price being based on cost, no unrealized profit or loss arises;
3. Closing stock will be at cost reflecting current market value;
4. The method is simple and easy to operate.
5. It is based on a clear assumption of movement of materials in stores.

Disadvantages of FIFO are given below:

1. Price fluctuations are reflected in fluctuations in cost of production;
2. It involves considerable clerical work.
3. During periods of rising prices, product costs are understated and profits are overstated. The opposite
would be the effect when prices fall.
4. Issue price does not reflect current market price and so does cost of production.

Islamic University, Kushtia

 Prepared y SM Nahidul Islam 4
Dept. of Finance & Banking

Last in First out Method (LIFO): Under this method materials received last are issued first. The price of
the material to be issued would the cost price of the last lot of materials purchased. This method is useful
during the period of rising prices because materials will be issued from the latest consignment a price which
is closely related to the current price levels. Under this method product' cost is calculated on a basis which
approximates to replacement cost.
The following are the advantages of LIFO method:
1. Issues are based on purchase price or cost.
2. Product cost will be more realistic.
3. Facilitating matching of cost with current sales revenue.
4. Fixation of selling price is facilitated.

This method suffers from the following disadvantages:

1. The methods involve tedious calculations when purchases are frequent at varying prices.
2. Under this system, closing stocks are not shown at current market price.
3. Sometimes more than one price has to be adopted for pricing a single requisition.
4. When prices are falling it will lead to low charge to production.
5. This system of material issue is not accepted by Income Tax Authorities.

Islamic University, Kushtia