Material Cost and Employee Cost
Weightage: Chapters 2 and 3 of ICAI's Paper 4 syllabus, together roughly 14 marks. Two direct-cost elements, each with its own recurring computational shape.
Material Cost
The material cost cycle
Material moves through a fixed sequence — purchase, storage, issue — and the costing questions at this level attach to each stage.
Purchase — Economic Order Quantity (EOQ)
The question EOQ answers: how much should be ordered at a time, to minimise the total cost of ordering plus carrying inventory?
where A = annual demand (units), O = ordering cost per order, C = carrying cost per unit per annum.
The intuition worth holding onto: ordering more at a time means fewer orders (lower total ordering cost) but more average inventory (higher total carrying cost); ordering less at a time reverses both. EOQ is the order quantity at which these two opposing costs are minimised in total — not where either is individually minimised, but where their sum is lowest, which occurs where the two cost curves intersect.
Reorder levels and stock levels
Reorder Level = Maximum consumption rate × Maximum reorder period (the level at which a fresh order must be placed, set high enough to cover the worst-case combination of usage rate and delivery delay).
Minimum Stock Level = Reorder Level − (Normal consumption rate × Normal reorder period).
Maximum Stock Level = Reorder Level + Reorder Quantity − (Minimum consumption rate × Minimum reorder period).
Average Stock Level = Minimum Stock Level + ½ × Reorder Quantity (or, alternatively, ½ × (Minimum + Maximum)).
Danger Level = Average consumption rate × Lead time for emergency purchase — the level signalling that normal reordering has failed and emergency procurement is needed to avoid a stockout.
Issue — valuation methods
Where materials of the same kind were purchased at different prices, issues must be valued by a chosen method, and the choice affects both the cost charged to production and the value of closing stock:
FIFO (First In, First Out) — issues are priced at the cost of the oldest batch in stock, so closing stock is valued at the most recent prices; in a period of rising prices, FIFO produces a lower cost of production and a higher closing stock value than the alternatives, because older, cheaper costs are charged to production first.
LIFO (Last In, First Out) — issues are priced at the cost of the most recently received batch, so closing stock is valued at older prices; in a period of rising prices, LIFO produces a higher cost of production and a lower closing stock value. Note: LIFO is not permitted for financial reporting under AS 2 (Foundation-level material), but the method itself remains examinable in this costing paper, since costing and financial reporting serve different purposes and are not bound by the same standard.
Weighted Average — a new weighted average cost is computed after every receipt, and all issues until the next receipt are valued at that average, smoothing price fluctuations rather than tracking specific batches.
Treatment of specific items
Normal loss in storage or handling (evaporation, breakage within tolerance) is absorbed by inflating the effective cost per unit of the remaining good units, since the cost of the material actually purchased must still be recovered from what survives.
Abnormal loss is costed separately and charged to the costing profit and loss account, not absorbed into the cost of good units.
Material handling/procurement overhead, if not directly identifiable to specific materials, is treated as a general overhead rather than added to material cost item by item.
Employee (Labour) Cost
Direct versus indirect labour
Direct labour cost can be traced to a specific cost object — the wages of an operator working directly on a specific job or product. Indirect labour cannot be so traced — supervisors, maintenance staff, general factory labour — and is treated as an overhead.
Methods of remuneration
Time rate — paid for time worked, regardless of output; simple, provides no direct output incentive, suited to work where quality matters more than speed or where output cannot be easily measured.
Piece rate — paid per unit of output, regardless of time taken; directly rewards higher output but can compromise quality if not paired with inspection, and provides no income security in periods of low output through no fault of the worker.
Differential piece rate schemes (Taylor's, Merrick's) pay a higher rate per piece once a standard output level is reached, sharply increasing the incentive to reach and exceed the standard — Taylor's uses two rates (a lower rate below standard, a substantially higher rate at or above standard); Merrick's uses three graduated rates based on efficiency bands (typically below 83%, 83–100%, above 100%, with the specific bands as notified).
Premium bonus schemes — Halsey and Rowan
Both schemes reward a worker who completes a job in less than the standard (allowed) time, but they split the resulting time saved between the worker and the employer differently, and this difference is the most frequently tested computational point in the labour chapter.
Halsey Plan. Bonus = a fixed percentage (typically 50%) of the time saved, valued at the time rate.
Rowan Plan. Bonus = the proportion of actual time that the time saved bears to the standard time, valued at the time rate.
The comparison that is always worth doing. At low levels of time saved (efficiency), Rowan pays a higher bonus than Halsey; at high levels of time saved, Halsey pays a higher bonus than Rowan, and the two schemes intersect at the point where time saved equals half the standard time. This is because Rowan's bonus formula contains time saved in the numerator and standard time in the denominator, causing the bonus to rise and then fall as a proportion of time worked as time saved increases towards the full standard time, capping the incentive to work at an implausibly extreme pace; Halsey's bonus, being a flat percentage of time saved throughout, keeps rising linearly with no such moderation.
Labour turnover
Labour turnover measures the rate at which employees leave and are replaced, and it is computed by three distinct methods, each answering a slightly different question:
The distinction between separation and replacement matters where a company reduces headcount (separations without matching replacements, as in a genuine downsizing) as against where it maintains headcount (each departure matched by a new hire); a company can have a high separation rate and a low replacement rate simultaneously, and reading which of the three rates a question is actually asking for is itself part of what is examined.
Costs of labour turnover are grouped into preventive costs (incurred to keep turnover low — welfare facilities, medical benefits, training investments intended to retain staff) and replacement costs (incurred as a consequence of turnover having occurred — recruitment, training of the replacement, lower initial productivity, increased breakage/wastage during the learning period).
Idle time and overtime
Idle time is time paid for but not worked. Normal idle time (routine tea breaks, machine setup, unavoidable minor stoppages) is treated as a factory overhead, absorbed into production cost generally. Abnormal idle time (a major breakdown, a strike, a power failure) is costed separately and charged to the costing profit and loss account, following the same normal/abnormal logic that governs material losses.
Overtime premium — the extra amount paid over the normal rate for hours worked beyond normal hours — is treated as an overhead if it arises from general pressure of work; but where overtime is worked at a specific customer's request to meet an urgent order, the premium may be charged directly to that job, since it is then a cost directly attributable to fulfilling that specific customer's requirement rather than a general cost of running the factory.
