CHAPTER

3 ACCOUNTING FOR
MATERIALS
 Learning Outcomes
 Understand material controls
 Explain the procurement and control procedure
 Understand stock investment and control
 Determine the economic order quantity (EOQ)
 Explain the assumptions of the EOQ formula
 Determine when to place the order
 Describe control of stocks through classification
 Explain pricing materials issues
 Explain the JIT system
 Distinguish between JIT purchasing and JIT
production
 Material Control
Types of materials
 Direct materials
 Indirect materials

Material control
 a system that ensures that various departments
within an organization coordinate their activities to
achieve efficient materials planning, purchasing and
usage
 Features of an Effective
Material Control System
Key features:
uses proper forms and records
consider effective purchasing methods
Provides adequate storage facilities
operates efficient stock control records
maintains proper planning and scheduling of
materials requirement
Maintains material cost within budget
Reasons for Material Control
System:
 To Minimize Capital “Tied-Up”
 To Ensure Sufficient Material is Held for
Production
 To Keep Proper Storage
 To Have Proper Stocktaking
[Link]
Control Cycle
Stages in Material Control
Cycle

Issue Purchase

Storage Receipt
 Material Control Cycle
MR PRN PO
N
Production Store Purchasing Supplier
department department department

GRN

GRN
Inspection Receiving
department department
INSPECTION
REPORT INVOICE
Account
department

Refer Figure 11 at page 24

 Procurement Procedures
Procurement procedure is a continuous process and it starts
from:

1. Initiating the purchase by storekeeper issuing a MRN.

2. The stores control department verifying and
subsequently issuing PRN.
3. Procurement department selecting the suppliers.
4. Procurement department placing PO and follow-up.
5. Receiving and inspecting the supply and returning
unwarranted suppliers (INSPECTION NOTES)
6. The goods and the GRN are sent to the stores.
7. Authorization of purchase INVOICES for payment
Document Descriptions
Material Used to request for materials to be used in the production
Requisition
Note (MRN)
Purchase Used to request for the purchase to be made for stock of raw
Requisition material for replenishment
Note (PRN)
Purchase Order Requesting supplier to supply orders of materials
(PO)

Invoice To charge and demand payment from the company

Goods To acknowledge that goods are received and checked against PO

Received Note
(GRN)
Inspection Inspection made upon receiving materials for quality & etc
Note
12
13
14
15
 2.
Procurement
 PROCUREMENT

TRADITIONA
JUST IN TIME
L METHOD
 Traditional Method
 involved several steps—requisition, soliciting bids,
purchase order, shipping advice, invoice, and payment.
 Use more than one supplier to obtain the minimum cost.
 The purchasing process is time consuming

Negotiation Open-order Expending Receiving Receiving Transportati

status count inspection on
paperwork
1
9
Just-In-Time (JIT)
 Inventory strategy that company used to increase
efficiency and decrease waste by receiving goods only as
they needed.
 Eliminates non-value added activities (rework, product
inspection, quality control)

Negotiation Transportation
Features of JIT

Frequent & on- Reduced lead

Reduced order
time delivery times (order
quantities.
schedules. completion).

Have few reliable

Suppliers inspect
suppliers who are
material before
given long term
delivery.
contracts.
DIFFERENCES
Traditional Purchasing JIT Purchasing
Order quantities Based on trade off between Based on small lot sizes for
ordering cost & carrying production
cost

Delivery schedules Infrequent (high level Frequent (small lot sizes &
ordering cost) low ordering costs)

Delivery lead time Relatively long & relaxed Stringent & reduced
significantly

Parts quality Responsibility of the Responsibility of supplier

quality function in the
company

Supplier base Fairly broad Considerably smaller

 Traditional Purchasing
Negotiation Open-order Expending Receiving Receiving Transportation
status count inspection
paperwork

Negotiation Transportation

JIT Purchasing
Just In Time
Advantages Disadvantages
• Reduced the need for • More pressure on
central warehousing workers
& storage • Success is varied
• Reliable delivery • Resistant to change
schedules • Need employees’
• High quality materials commitment
used
• Receiving inspection
is reduced
 [Link]
investment &
control
 Inventory Investment
Important considerations that management must give are:

 Availability of storage space

 Availability of funds
 Storage and materials handling costs
 Risk of loss due to damage, obsolescence, pilferage or
deterioration and evaporation
 Delivery delays or lead time
 Economic order quantities
 Inventory Control Levels
The planning and maintenance of stock levels is
effected by the calculation of the following:

 Re-order level
 Minimum stock level KG
 Maximum stock level
 Re-order quantity
 Average stock level
Minimum Stock Level/ Safety Stock
Min. SL = ROL – (Avg Usage X Avg Lead time)

Maximum Stock Level

Maximum = ROL – (Min Usage X Min Lead time) + EOQ

Re-order Level
Re-order = Max Usage X Max Lead time

Average Stock Levels

Average Stock Level = Max stock level X Min stock level
2
 Test Your IQ….

Answer the question using the following data:

Consumption rate 60 – 130 units per day
Lead Time 20 – 26 days
EOQ 4,000 units

Required:
Determine ROL; Min. Stock Level; Max. Stock Level; and
Average Stock Level.
 Consumption rate: 60
– 130 units/day
…. Solution Lead time: 20 – 26
days
i. ROL = 130 X 26 EOQ: 4,000 units
= 3,380 units

ii. Min. Stock Level = 3,380 – [(60+130/2) X (20 + 26)/2)

= 1,195 units

iii. Max. Stock Level = 3,380– (60 X 20) + 4,000

= 6,180 units

iv. Average Stock Level = 1,195 + 6,180

2
= 3,688 units
 Inventory Control Levels

Example 3.1

Issue on over stocking & under stocking

 The objective of material is to maintain optimum stock. The

principle which should be kept in mind is that there should
not be any over stocking or under stocking of materials, as
both these situations involve costs.
Problems associated with...

Over Under
High cost of
stocking storage
stocking Production holdups

Need for security Firm may end up

measure paying for idle
labour cost

Money tied up in Organization may

stock lose its important
customers

Risk of Cannot cope with

deterioration of unexpected changes
stocks in demand
 Economic Order Quantity (EOQ)

 is the optimal order quantity that minimizes the total

inventory cost.
 total inventory cost consists of cost of ordering and
holding costs.

KG
 EOQ
 Underlying assumptions:

 Constant demand
 Constant carrying cost/ ordering cost
 Constant unit price
 Quick delivery
 Replenishment is made instantaneously
 Determining the EOQ

The EOQ and the total inventory costs can

be determined using a:

1. Formula approach,
2. Graphical approach, or
3. Tabulation approach.
The following notations are used to determine
the EOQ:

 Q = Quantity ordered each time

 D = Annual demand of parts (in unit)
 CH = Carrying cost per unit of individual item
 CO = Cost per order
 TC = Total annual costs
 EOQ Using the
Formula Approach

EOQ = 2 x Co x D
Cs

Co = Cost of Ordering

D = Annual Demand

Cs = Cost of Storage
 Calculate: EOQ Using the Tabulation Approach

1) No of order = D/Q (no of times)

2) Average Stock = Q/2

3) Annual Cost of Ordering = D/Q x Co

4) Annual Cost of Storage = Q/2 x Cs

5) Total cost

Refer examples at page 32 & 33

Quantity

No of orders
(D/Q)

Average
Stock (Q/2)

Annual Cost
of Ordering
(D/Qx Co)

Annual Cost
of Storage
(Q/2 c Cs)

TOTAL
COST
Example:
 The following information is available for a company:
Ch = RM1.50
Co = RM10
demand = 10,000 units

Calculate the annual holding costs and annual ordering

costs at the following different order quantities:
i. 100 units
ii. 1,000 units
iii. 2,000 units
Quantity

No of orders
(D/Q)

Average
Stock (Q/2)

Annual Cost
of Ordering
(D/Qx Co)

Annual Cost
of Storage
(Q/2 c Cs)

TOTAL
COST
EOQ Using the Graphical Approach
[Link]-
Keeping
Store-keeping
 Storekeeping is an important function to ensure
efficient operations of any organizations.

 Objectives of storekeeping mainly:

 To protect items in store from damage and deterioration.

 To secure store from pilferage, theft and fire.
Store-keeping
 Storekeeper receives materials, he enters the materials
received into the bin or on the shelf.
 Entries are also made in the Bin Card when materials
are issued from the store.
 Therefore, all the physical movement of materials are
recorded in the bin card.

Date Detail Receipts Issues Balance

Qty Qty Qty
Centralized storage
 Centralized storage is where
only a single area in a facility is
used for all storage and receipt
of material.
Centralized storage
Advantages Disadvantages
• Lower operation • Less convenient
costs for outlying
• Lower distribution branches
cost • More security
• Closer control needed
• Longer delays in
obtaining materials
 Decentralized storage
 Decentralized storage is the
use of multiple material
storage and receipt areas
that are located close to the
point of use of material.
[Link]-Take
STOKE TAKE

Perpetual Continuous Periodic

inventory system stocktaking stocktaking
• A sample of • It is carried out on
• Every time items are counted a specific date
materials are regularly. • A ‘cut-off’ time
received, issued & • An independent should be set
balance will be personnel will be where there is no
recorded in Store in charged movement of
Ledger Card stock is allowed
until the count has
been completed.
Store Ledger Card (format)

Date Detail Receipts Issues Balance

Qty Unit RM Qty Unit RM Qty Unit RM
price price price
Differences of stock balance between
stock cards and stock taking
 Error in recording process
 Loss due to theft or pilferages
 Loss due to natural factors e.g. rot, decay or evaporation
 Arithmetical errors in calculating stock balance
 Unrecorded stock
 Entry made in wrong store ledger card
 Item are placed in the wrong physical location
 6.
Issuance of Stock
& Method of
Stock Valuation
 Methods of Materials Pricing
 The most commonly used methods are:
Cost price methods:
 First-in-first-out (FIFO)
 Last-in-first-out (LIFO)
Average price methods:
 Weighted simple average

Refer example at page 39-41

 FIFO method
 The earliest material purchased are used 1st until finished
 The issued material will be recorded using the price of the
1st material purchased.
 It have the lowest COS thus, lead to higher profit
 FIFO method
Advantages Disadvantages
• Material are issued • Difficult to
at actual cost administered
• Stock value is • Material cost
presented fairly at based on oldest
current MV material prices
• Avoid obsolesces
of stocks
 LIFO method
 Last material purchased are the 1st to be utilized.
 Stock is valued at cost but may be valued at outdated
price.
 It have a high COS thus lead to lower profit
 LIFO method
Advantages Disadvantages
• Product cost is • Administratively
more realistic complicated
• Based on accrual • Closing stock
concept will be valued at
out of date price
• Induce
obsolesces
 Weighted Average method
 The average cost of all units in the stocks is computed
after every purchase.
 Average cost = Total Cost
No of units
 New price is calculated each time new materials are
received & not at the time when there is a new issue
Weighted Average method
Advantages Disadvantages
• Less complicated • Does not present
than FIFO & actual buying
LIFO price
• Easier to
compare cost
between jobs
The end