Mathematical Formula in Material Cost Accounting and Control - Essay Example

MATHEMATICAL FORMULA IN MATERIAL COST ACCOUNTING AND CONTROL Materials cost constitute the prime part of the total cost of production of manufacturing firms. Proper decision has to be made for the control of materials purchase, consumptions and inventories which are very important for effective management of a business firm. To maintain the materials cost at the minimum level, the organization has to purchase the materials in the most optimum size. If a company purchases in large quantities, the cost of carrying the inventory would be high because of the high investment involved.

Also, overstocking requires more storage space which, in turn, means increase in insurance expenses, storage costs and deterioration in quality and depreciation in quantity. On the other hand, if materials are under stocked, frequent orders have to be placed in small quantities and there is a chance of "stock outs" also. Hence, the tack of the manager is to find the most economic order which s very essential for cost management and control. The cost of carrying the inventory and the ordering cost are inversely proportional to each other.

The costs of placing the order decreases as the size of the order increases, because with the bigger size of order, the number of the orders will be lower. However, simultaneously the costs of carrying the inventory will go up because the purchases have be made in large quantities. It may be possible to have appoint which provides the lowest total cost and the point, which is the ideal size of the order is known as the Economic order Quantity(EOQ). The EOQ is one where the cost of carrying inventory is equal or almost equal to the cost of not carrying inventory (cost of placing the order), i.e., at EOQ level, the total of inventory carrying cost and the ordering cost is minimum which can be determined mathematically s follows:Where, U = Units consumed annuallyO = Cost of placing an orderI = Carrying cost as a percent of inventoryC = Cost per unit of materialFor example, if the annual usage is 6000 units.

, cost of placing an order is $ 30, carrying cost as a percent cost of inventory is 20% and cost per unit of material is $ 5, then, 2 x 6000 x 30 EOQ = 5 x 20 % = 600 units.The EOQ is 600 units, i.e., 10 orders per year is needed. The materials manager has to collect data about the average annual consumption, the average cost of placing and order and the carrying cost a percent of inventory of the particular material to calculate the EOQ. If this mathematical model is not used, the alternate method to find the EOQ is to make a table from the previous years about the number of orders placed per year, the average order size; average inventory carrying cost, order cost and the total cost has to be estimated.

The order size which gives the least amount of total cost has to be selected as the EOQ. But instead if this model is used, time and cost can be saved.