Chapter 7

Planning and Controlling Purchases and

Materials Usage: manufacturing and
Nonmanufacturing

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 Learning Objectives

After studying this chapter, you should be able to

describe the coordination among:
1. Production requirements for materials and
component parts.
2. Raw material and parts inventory level.
3. Purchases of raw material.

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 The Raw Materials and Component
Parts Budget
A tactical short-term profit plan should include:
1. A detailed budget that specifies the quantity
and cost of raw materials and components
parts.
2. A related budget of materials and parts
purchases

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• The Material and Purchases Budget
- Sub budgets
1. Materials and Parts Budget
2. Materials and Parts Purchases Budget
3. Materials and Parts Inventory Budget
4. Cost of Material and Parts Used Budget

In simple situations, all four may be

combined.

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1. The Material and Parts Budget

Materials are classified as direct or indirect.

Direct material is generally defined to include
all materials and parts that are an integral
part of the finished products.
Direct material cost is usually a variable cost -
that is, a cost that varies in proportion to
changes in productive output or volume.

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• The Material and Parts Budget
(cont.)
• The materials budget includes only the quantities
(not cost) of direct materials, factory supplies, and
indirect materials are included in the
manufacturing overhead budget.

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• The Material and Parts Budget
- Basic Inputs
1. Volume of output planned from the
production plan.
2. Standard usage rates by type of raw
material and part of each finished product.
In planning the materials and parts budget,
realistic allowances must be made for normal
spoilage, waste and scrap.

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2. The material and Parts Purchases and
Inventory Budgets
The purchases budgets specifies:
1. The quantities of each type of material and
part to be purchased.
2. The timing of those purchases.
3. The estimated cost of material and part
purchases. (per purchased unit and in
total).

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• Purchasing Manager Responsibilities

1. Adhering to management policies about

materials and parts inventory levels.
2. Determining the number of units and the
timing of each type of material and part to
be purchased.
3. Estimating the unit cost of each type of
material and part to be purchased.

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3. Materials and Parts Inventory Policies
-Primary Considerations in setting inventory policies
1. Timing and quantity of manufacturing needs
2. Economies on purchasing through quantity
discounts
3. Availability of materials and parts
4. Lead time (order and delivery)
5. Perishability of materials and parts
6. Storage facilities needed

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 Materials and Parts Inventory Policies
-Primary Considerations in setting inventory policies
7. Capital requirements to finance inventory
8. Cost of storage
9. Expected changes in the cost of materials and
parts
10.Protection against shortage
11.Risk involved in inventories
12.Opportunity costs (inadequate inventory)

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• Considerations in setting purchasing
Policies
1. How much to purchase at a time
2. When to purchase
The Economic Order Quantity Model

Where: A = Annual quantity used in units

O = Average annual cost of placing an order
C = Annual cost of carrying one unit in
inventory for one year.

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• Reorder Point

The reorder point is reached when the inventory

level is equal to the quantity needed to sustained
production for a period equal to the time to
reorder and receive the replenishments.
UNITS
Average monthly usage planned (5,400 / 12) 450
Two-week replenishment provision (450/2) 225
Add safety stock provision 225
Reorder point (reorder when inventory level reaches 450
this level)

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4. Estimating Unit Cost for Materials and
Parts
The purchasing manager is responsible for
estimating the unit cost of each raw material and
part.
When a changing unit price is planned for
materials and parts, the budget of the cost of
materials and parts used and the related
inventory budget must be developed using a
selected inventory flow such as FIFO, LIFO,
moving average or weighted average.
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