Material costing

Habari! Let's Talk About the 'Dough' in the Mandazi!

Welcome back, future accounting expert! Ever wondered how a successful bakery, like one in your neighbourhood, decides the price of a single mandazi? They can't just guess! They need to know exactly how much the flour, sugar, cooking oil, and everything else costs. That, my friend, is the heart of Material Costing.

In this lesson, we're going to become detectives. Our mission? To track and calculate the cost of materials from the moment a business decides it needs them to the moment they are used to create a product. This skill is vital for any business in Kenya, from a jua kali artisan making metal gates to a large company like Kenya Breweries Limited. Let's get started!

What Exactly is 'Material'?

In cost accounting, 'material' is the substance from which a product is made. We split materials into two main types:

• Direct Materials: These are the main ingredients you can easily trace to the final product. They form a major part of the item.
• Indirect Materials: These are necessary for production but are not easily traced to a single product. Think of them as the 'helpers'.

Scenario: A Fundi Making a Wooden Table in Ngara
Imagine a carpenter, let's call him Kamau, who has a workshop in Ngara.

• His direct materials would be the large planks of Cypress wood and the metal legs. You can see and measure exactly how much wood went into one table.
• His indirect materials would be things like glue, sandpaper, varnish, and the cleaning rags used to wipe the table. It's difficult to say, "Exactly 5 shillings worth of glue was used on this specific table," so these costs are treated indirectly.

The Journey of Materials: From a Need to the Store

A business can't just have materials appear out of thin air. There's a proper, controlled process to make sure the right quality and quantity are bought at the right price. This is called the procurement process.

**A Simple Procurement Flowchart**

[Step 1: Need is Identified]
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       V
[Step 2: Purchase Requisition Note is raised by the Stores department]
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[Step 3: Purchasing Department sends a Purchase Order to the Supplier]
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       V
[Step 4: Supplier Delivers Goods with a Delivery Note]
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       V
[Step 5: Our Storekeeper receives goods and signs a Goods Received Note (GRN)]
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       V
[Step 6: Supplier sends an Invoice]
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       V
[Step 7: Accounts Department checks all documents and makes Payment]

Following this process prevents theft, ensures quality, and helps control costs. Every step has a paper trail!

Image Suggestion:

A vibrant, colourful illustration showing the procurement process in a Kenyan context. Scene: A busy warehouse yard for a company like "Nakuru Feeds Ltd." In the foreground, a storekeeper with a clipboard (the GRN) checks off sacks of maize being unloaded from a lorry. In the background, an office worker is on the phone, pointing to a Purchase Order on their screen. The style should be clear, educational, and slightly cartoonish to be engaging.

The Million-Shilling Question: How Do We Value Our Stock?

Now for the most important part! Imagine a business buys the same material, say, bags of cement, at different times and at different prices. When the construction team takes a bag from the store, what cost do we use? This is crucial for calculating the cost of a project and the value of the cement left in the store.

We use different methods for this. The three main ones you need to master are FIFO, LIFO, and Weighted Average.

1. FIFO (First-In, First-Out) - The Kiosk Owner's Method

This method assumes that the first materials you buy (First-In) are the first ones you use or sell (First-Out). Think about a duka owner selling milk or bread. They will always sell the oldest stock first to avoid it expiring!

Example: Uji Flour Ltd.
Uji Flour Ltd. had the following transactions for Wimbi flour in January:

• Jan 1: Opening Balance: 100 bags @ KES 1,000 each
• Jan 5: Purchased: 200 bags @ KES 1,200 each
• Jan 15: Issued to Production: 250 bags

How do we cost the 250 bags issued? With FIFO, we issue the oldest stock first.

**Stores Ledger Card - FIFO Method**

We need 250 bags.
1. Take the first batch (oldest): 100 bags @ KES 1,000 = KES 100,000
2. We still need 150 more bags (250 - 100).
3. Take these from the next batch: 150 bags @ KES 1,200 = KES 180,000

Total Cost of Issue = 100,000 + 180,000 = KES 280,000

**What's left in the store (Closing Stock)?**
From the Jan 5 batch, we used 150 out of 200 bags.
Remaining = 50 bags @ KES 1,200 = KES 60,000

2. LIFO (Last-In, First-Out) - The Construction Site Method

This method assumes that the last materials you bought (Last-In) are the first ones you use (First-Out). Imagine a pile of sand or gravel at a construction site. The newest delivery is dumped on top of the pile, so it's easiest to use that first!

Important Note: LIFO is not permitted under International Financial Reporting Standards (IFRS), which Kenya follows. However, you must learn it for your exams and to understand different costing theories.

Example: Uji Flour Ltd. (again!)
Let's use the same data, but with the LIFO method.

• Jan 1: Opening Balance: 100 bags @ KES 1,000 each
• Jan 5: Purchased: 200 bags @ KES 1,200 each
• Jan 15: Issued to Production: 250 bags

**Stores Ledger Card - LIFO Method**

We need 250 bags.
1. Take the last batch first: 200 bags @ KES 1,200 = KES 240,000
2. We still need 50 more bags (250 - 200).
3. Take these from the older batch: 50 bags @ KES 1,000 = KES 50,000

Total Cost of Issue = 240,000 + 50,000 = KES 290,000

**What's left in the store (Closing Stock)?**
From the Jan 1 batch, we used 50 out of 100 bags.
Remaining = 50 bags @ KES 1,000 = KES 50,000

See how the cost of issue and closing stock are different depending on the method? This is why it's so important!

3. Weighted Average Cost (AVCO) - The 'Mix-It-All-Up' Method

This method is used when materials are mixed together and you can't tell the old from the new, like petrol in a station's underground tank or grain in a silo. We calculate a new average cost per unit every time we receive a new batch of materials.

The Formula:

Weighted Average Cost = Total Cost of Materials in Stock / Total Quantity of Materials in Stock

Example: Uji Flour Ltd. (one last time!)
Same data, let's calculate the AVCO.

• Jan 1: Opening Balance: 100 bags @ KES 1,000 each (Total Cost: 100,000)
• Jan 5: Purchased: 200 bags @ KES 1,200 each (Total Cost: 240,000)
• Jan 15: Issued to Production: 250 bags

**Stores Ledger Card - AVCO Method**

1. After the purchase on Jan 5, let's calculate the new average cost.
   Total Cost = 100,000 (old) + 240,000 (new) = KES 340,000
   Total Quantity = 100 bags (old) + 200 bags (new) = 300 bags
   
   New Average Cost per bag = 340,000 / 300 = KES 1,133.33

2. Now, we issue the 250 bags at this new average cost.
   Cost of Issue = 250 bags * KES 1,133.33 = KES 283,332.50

**What's left in the store (Closing Stock)?**
Remaining Quantity = 300 - 250 = 50 bags
Value of Closing Stock = 50 bags * KES 1,133.33 = KES 56,666.50

Becoming a Stock Management Guru: EOQ and Stock Levels

Great accountants don't just record costs; they help manage them! A key part of material costing is ensuring you have enough stock (but not too much!). Too little, and production stops. Too much, and you're tying up cash and paying for a huge warehouse!

Economic Order Quantity (EOQ)

EOQ is a formula that helps a business decide the most economical quantity of stock to order at one time. It balances two types of costs:

• Ordering Costs: Costs of placing an order (admin, transport from Mombasa port, etc.).
• Holding Costs: Costs of keeping stock (warehouse rent, insurance, risk of theft).

The goal is to find the 'sweet spot' where the total cost is lowest.

      /**********\
     /    EOQ     \
    /--------------\
   /  Ordering    \
  /     Costs      \
 /------------------\
/   Holding Costs    \
\********************/

Image Suggestion:

A simple, clean line graph for a presentation slide. The X-axis is 'Order Quantity' and the Y-axis is 'Cost'. One line (e.g., blue) slopes downwards from left to right, labeled 'Ordering Costs'. Another line (e.g., red) slopes upwards from left to right, labeled 'Holding Costs'. A U-shaped curve (e.g., green) represents the 'Total Cost'. The lowest point of the Total Cost curve should be clearly marked with a dotted line dropping to the X-axis, labeled 'EOQ (Economic Order Quantity)'.

Stock Levels

Businesses set different levels to manage their inventory effectively.

      +-----------------+  <-- Maximum Stock Level (Don't order more!)
      |                 |
      |=================|  <-- Re-order Level (Time to call the supplier!)
      |                 |
      |-----------------|  <-- Minimum Stock Level (Safety/Buffer Stock)
      +-----------------+  <-- Danger! Stock-out risk.

• Re-order Level: The point at which a new order for materials should be placed.
• Minimum Stock Level: A 'safety' or 'buffer' stock that should be kept at all times just in case of delays.
• Maximum Stock Level: The most stock you want to hold to avoid high holding costs.

Let's Wrap It Up!

Phew, that was a lot, but you did great! Today, we've seen that material costing is more than just numbers. It's a system for controlling one of the biggest expenses in any manufacturing business.

You have learned to:

1. Distinguish between direct and indirect materials.
2. Understand the procurement process.
3. Calculate the cost of materials issued and closing stock using FIFO, LIFO, and Weighted Average.
4. Appreciate the importance of stock management concepts like EOQ and stock levels.

Keep practicing the calculations. The more you do, the easier they become. You're building a fantastic foundation for your career in accounting. Well done!