COURSE AFAR 1: COST ACCOUNTING

This module is prepared by professor Venus L. Catacutan. She’s an

associate professor in the College of Business and Accountancy-
Accountancy department at Tarlac State University . Being a Certified
DEVELOPER AND THEIR BACKGROUND
Accountant, in addition to her teaching profession, shes’ likewise
involve in public practice which brings to this module some
experiences on specialized accounting concerns of different industries.

COURSE DESCRIPTION

COURSE OUTLINE

CHAPTER 3
TITLE ACCOUNTING FOR MATERIALS
I. RATIONALE
The very first topic of the course is Partnership formation, the expected
learning to be achieved by the student are properly disclosed in the
learning objectives stated below. Prior to taking this course, a student
must have already a concrete knowledge on basic accounting
concepts, and skills in preparing financial statements otherwise the
user of this module must review the basic and financial accounting
undertaken in previous courses(preparatory activities)
INSTRUCTION TO THE USERS
The developmental activities section provides the comprehensive and
vital information concerning accounting for partnership formation. For
assessment of learning,closure activities like theoretical questions
and problem solving with different degree in terms of difficulty were
provided. For evaluation , see the evaluation sectionfor details, and
lastly for activities and preparation to be undertaken for next topic this
module provides the student/s the details.

At the end of the chapter, the student should be able to:

 Describe a system if materials procurement and use.
 Identify the components of the cost of acquiring materials.
II. LEARNING OBJECTIVES
 Define and calculate the order point.
 Define and calculate safety stock.
 Describe the ABC plan inventory control
III. CONTENT
A. PREPARATORY ACTIVITIES 1.
B. DEVELOPMENTAL ACTIVITIES

MATERIALS CONTROL

Certain requirements are essential to an effective internal control system for materials, as follows:
 Materials of the desired quality must be available when needed.
 Correct quantities and types of materials must be on hand at the right time for production to proceed on
schedule.
 Materials must be purchased at the most favorable prices.
 Materials must ne protected from lost or theft.
 Risks of spoilage and obsolescence must be minimized.
 Cost of materials handling, and storage must be kept to a minimum.

Modern systems of inventory control include the following features:

 Physical safeguards for receiving, storing, and issuing materials.
 Formal procedures for ordering and paying for materials.
 Perpetual inventory system to provide an ongoing record of the quantity and value of each type of materials
received and issued and the balance on hand.

Organization for Control

1. Purchasing Department – This department is charged with the responsibility of placing orders for materials with
 reliable suppliers, at the right time and at the right price.
2. Receiving Department – This department is charged with the inspection of incoming shipments and verification
of the quantities received on order.
3. Storeroom (Stockroom) – This department is responsible for protecting materials against material deterioration
and ensuring that the stocks are properly issued.
4. Accounting Department – This department records all transactions in the accounts after documentary evidence
have been supplied by other departments.
5. Cash Department – This department pays all invoices after approval by the accounting department.

Materials Procurement and Use

Although production processes and materials requirements vary according to a firm’s size and industry, the
procurement and use of materials usually involve the following steps:

1. For each product or product variation, engineering determines the routing for ach product, which is the
sequence of operations to be performed, and establishes the bill of materials, which is the list of materials
requirements for each step in the sequence.
2. The production budget provides the master plan from which details concerning materials requirements are
developed.
3. The purchase requisition informs the purchasing agent of the quality and kind of materials needed.
4. The purchase order contracts for quantities to be delivered.
5. The receiving report certifies quantities received and may report results of inspection and quality testing.
6. The materials requisition authorizes the storeroom or warehouse to deliver specified types and quantities of
materials to a given department at a specified time.
7. The materials record cards record each receipt and issuance of each kind of material and serve as
perpetual inventory records.

Purchasing Forms

1. Purchase requisition
 Originates from storeroom employee who observes that the quantity on hand is at a set ordering
point
 originates from a materials record clerk responsible for notifying the purchasing agent when to buy
 originates from a research, engineering, or other department employee or supervisor who needs
materials of a special nature
 originates from a computer programmed to alert the purchasing department when replenishment is
needed.
2. Purchase order
 signed by the purchasing agent or other official
 authorization to a vendor to supplied specified quantities of described goods at agreed terms and
at designated time and place.
3. Electronic Data Interchange (EDI)
 exchange of transaction information between the computer in one company and the computer in
another.

Cost of Acquiring Materials

 Materials are commonly carried at invoice price paid to the vendor, and acquisition costs and price
adjustments are treated as factory overhead.
 Trade discounts and quantity discounts normally are not entered into accounting records. Instead, they are
treated as price reductions.
 Cash discounts – amount charged to materials often is determined before any deductions of cash discounts.
The account Cash Discounts is credited, to avoid the necessity of computing a cash discount on each
materials item.
 Freight-in are included in the general ledger debit to Materials, then freight cost can be added
proportionately to each materials record card. Alternatively, charge all freight-in cost to an account entitled
Freight-in and record only the invoice cost as the cost of materials. As the materials are issued, an applied
rate, for freight charges is then added to the unit cost on the materials record cards. For materials or
supplies used in marketing and administrative departments, freight is charged to Marketing Expenses or to
Administrative Expenses.
 Applied Acquisition Cost – If materials cost is to include acquisition costs, an applied rate can be added to
each invoice and to each item, instead of charging these costs to factory overhead. A single rate for these
costs can be used, or separate rates for each class of costs as follows:
Estimated purchasing department cost for budget period
 = Rate per purchase
Estimated number of purchases∨estimated amount of purchases
 
Estimated Receiving Department Cost for Budget Periof
be received duing period ¿ =
Estimated number of items ¿
Rate for Item
Estimated Materials Department Cost for Budget Period
 = rate per item, cubic foot,
estimated number of items , feet of space , dollar value , etc .
dollar, etc.
Estimated Applicable accounting department cost for budget period
 = Rate per
Estimated number of transactions
Transaction
 Journal Entry:
Materials (or WIP) xx
Applied Purchasing Dept. Costs xx
Applied Receiving Dept. Cost xx
Applied Materials Dept. Cost xx
Applied Accounting Dept. Cost xx

Issuing and Costing of Materials

Materials Requisition
 authorizes the storekeeper to issue materials.
 drawn by production control clerk, department head supervisor, group leader or expediter.
 used to withdraw materials from the storeroom
 source document for entries in the issued section of materials record cards, the direct materials section of job
cost sheet and the departmental overhead analysis sheets.

Electronic Data Processing for Materials Requisitions

 the requisition information is entered and transmitted electronically rather than in written form.
 the system produces materials summaries as needed and updates subsidiary records and general ledger
accounts automatically.

Bills of Materials
 List of all materials necessary for typical job or production run
 serving as master copy of materials requisition for that product

QUALITATIVE MODELS

Materials planning deals with two fundamental factors:

1. Quantity
2. Time to purchase

Economic Order Quantity (EOQ)

 Amount of inventory ordered at one time that minimizes annual inventory cost.
 Optimum quantity to order which is determined by balancing the two factors:
A. Carrying Cost - cost of possessing materials which are often expressed as percentages of the
average inventory investment
B. Ordering Cost – cost of acquiring materials. It includes preparing a purchase requisition, purchase
order and receiving report, handling the incoming shipment; communicating with the vendor; and
accounting for shipment and payment.
Formulas:

RU
 Number of Orders Placed Annually =
EOQ

RU xCO
 Annual Ordering Cost =
EOQ

EOQ
 Average number of units in inventory at any point in time =
2
 CUx CCx EOQ
 Annual Carrying Cost =
2

 Total Annual Cost of Ordering and Carrying inventory, designated as AC =

RU x CO CU x XX x EOQ
+
EOQ 2

2 x RU x CO
 EOQ =
√ CU x CC

where:
o RU = Annual required units
o CO = Cost per Order
o CU = Cost per unit of material
O CC = Carrying Cost Percentage

ILLUSTRATION.

Assume that annual requirement of 2,400 units, a cost per unit of $.75, an ordering cost of $20 per order, and a
carrying cost percentage of 20%.

2 x 2,400 x $ 20 $ 96,000
 EOQ =
√ $ .75 x .20
= EOQ =
√.15
= EOQ = √ 640,000 = 800 units

When to Order

o Order point – reached when available quantity is just equal to the foreseeable needs; that ism when the sum
of inventory on hand and quantities due in equals the sum of lead time usage quantity and safety stock
quantity. Order point can be expressed as:

I + QD = LTQ +SSQ

Where:
I = inventory balance on hand
QD = Quantities due in (before depletion of I) from orders previously placed, materials transfers,
and returns to stock
LTQ = Lead time quantity, which equals normal lead time in months, weeks or days, multiplied by a
normal month’s, week’s or day’s use
SSQ = Safety Stocks Quantity

o Lead time – the interval between the time an order was placed and the time when the materials are on the
factory floor ready for production

o Usage - the anticipated rate at which materials will be used

o Safety Stock – the estimated minimum level of inventory needed to protect against running out of stock.

Illustration. if the weekly usage of a stock item is 175 units, and the lead time is normally 4 weeks but possibly as
long as 9 weeks, then the order point is 1.575 units: 700 units usage during normal lead time (175x 4 weeks) plus
875 (175 x 5 weeks). Assuming the beginning inventory of 2,800 units with no orders outstanding, the usage, order
schedule and maximum inventory levels are:
Units in beginning inventory 2,800
Less: Usage to order point (1,225 / 175 weekly usage = 7 1,225
weeks)
Order Point 1,575
Less: Usage during normal lead time (700 / 175 weekly = 4 700
weeks)
Maximum inventory or safety stock at date of delivery, 875
assuming normal lead time and usage
Add: Order Quantity units received 2,090
Maximum inventory, assuming normal lead time and usage 2,965

Commonly Used Control Procedures

 a. Order Cycling – method where materials on hand are reviewed on a regular or periodic cycle.
b. Min-Max Method – once the specific minimum and maximum quantities were determined , the minimum
quantity will represent the order point.
c. Two-bin Method – Under this, materials are divided and placed into two separate bins. The quantity of
materials that will be used between the time an order is received and the next order is placed will be on the
first bin . The second bin will contain the quantity of materials that will be used between the ordering and
delivery plus additional units of safety stock. When the first bin is emptied, an order is places. The contents
of second bin will be used until the receipt of the shipment.
d. Automatic order system – an order is automatically placed when level of inventory reaches an
predetermined order point quantity.
e. ABC Plan – method used by companies with a large number of materials, each one having a different value.
It is a systematic way of grouping materials into separate classification and determining the degree of
control that each group requires.

METHODS OF COSTING MATERIALS

 First In, First Out (FIFO) – based on the assumption that cost should be charged to manufacturing cost or
cost of goods sold in the order in which incurred. The inventories are stated in terms of the most recent cost
and expense is charged with the earliest costs incurred.
 Weighted Average Method – used for periodic inventory system. This method is based on the assumption
that the units should be charged t an average cost, such average being influenced or weighted by the
number of units acquired at each price. The inventory at the end is computed by multiplying the weighted
average cost per unit by the units on hand.
 Moving Average Method – When perpetual inventory system is used a new weighted average unit cost is
calculated after each new purchase and this amount is used to the cost each subsequent issuance until
another purchase is made.

SPOILED UNITS, DEFECTIVE UNITS, SCRAP MATERIALS, AND WASTE MATERIALS IN A JOB ORDER COST
SYSTEM

 Spoiled Units – units that do not meet production standards and are either sold for their salvage value or
discarded. When spoiled units were discovered, they are taken out of production and no further work is
performed on them.
 Defective Units – units that do not meet production standards and must be processed further in order to
become saleable as good units or as irregulars.
 Scrap Materials – left over from production standards that cannot be put back into production for the same
purpose but may be usable for different purpose or production process or which may be sold to outsiders for
nominal amount.
 Waste Materials – leftovers from the production process that has no further use or resale value and may
require cost for their disposal.

Two Methods of Accounting for Spoiled Materials

1. Charge to Specific Goods – this method is used if the reason for spoilage is the job itself because it requires
exacting specifications, or a difficult, intricate, or complicated manufacturing process. The effect of this
method is that it will increase the unit cost of the perfect finished articles in the job.

Journal Entry:
Spoiled Goods XX @ est. sales value per unit
Work in Process XX

2. Charged to All Productions – this method is used if the reason for the spoilage is considered normal to the
process and the number does not exceed the limit set by the company.

Journal Entry:
Spoiled Goods XX @ est. sales value per unit
Factory Overhead Control XX (SQUEEZE)

Work in Process XX @ tot. cost incurred/charged

Two Methods of Accounting for Spoiled Materials

1. Charge to Specific Goods – same for spoiled units, if the reason for the defect is the job itself, the additional
 costs incurred (materials, labor, and overhead) will be charged to all units in the job.

Journal Entry:
Work in Process XX
Materials XX
Payroll XX
Factory Overhead Applied XX

2. Charged to All Production – if the reason is normal to the process and the number of the defective units
does not exceed the normal limit, then the additional costs incurred will be charged to all units being
processed during the period.

Journal Entry:
Factory Overhead Control XX
Materials XX
Payroll XX
Factory Overhead Applied XX

Accounting for Scrap Material

1. If the scrap can be traced to specific job

Journal Entry:
Scrap/ Scrap Materials XX
Work in Process XX

2. If the scrap recovered are not traceable to a specific job

Journal Entry:
Scrap/ Scrap Materials XX
Miscellaneous Income XX

3. If the scrap recovered are from factory supplies

Journal Entry:
Scrap/ Scrap Materials XX
Factory Overhead Control XX

Accounting for Waste Materials

1. If the cost of disposing the waste materials is allocated to all jobs

Journal Entry:
Factory Overhead Control XX
Accounts Payable XX

2. If the cost of disposing the waste materials is allocated to a specific job

Journal Entry:
Work in Process Inventory – (job number) XX
Accounts Payable XX

ILLUSTRATIONS

Job 3044 called for the making of 4,000 with these unit costs:

Direct Materials P 15.00

Direct Labor 13.00
FOH ( includes P1.00 allowance for spoiled work) 12.00

CASE A. When the order was completed, 200 rejected units, a normal number, were sold for P18.00 each.
a.1. Assume that the loss is charged to all production

Journal Entries:

a.
Work in Process 160,000
Materials 60,000
Payroll 52,000
Factory Overhead Applied 48,000
b.
Spoiled Goods 3,600
Factory Overhead Control 4,400
Work in Process 8,000

c.
Finished Goods 152,000
Work in Process 152,000

a.2. Assume that the loss is charged to Specific Job

a.
Work in Process 156,000
Materials 60,000
Payroll 52,000
Factory Overhead Applied 44,000

b.
Spoiled Goods 3,600
Work in Process 3,600

c.
Finished Goods 152,400
Work in Process 152,400

CASE B. During the processing, 300 were found to be defective and required the following total additional costs:
materials – P2,000; labor – P4,000; and overhead – P2,000.

b.1. Additional cost is charged to all productions

a.
Work in Process 160,000
Materials 60,000
Payroll 52,000
Factory Overhead Applied 48,000

b.
Factory Overhead Control 8,000
Materials 2,000
Payroll 4,000
Factory Overhead Applied 2,000

c.
Finished Goods 160,000
Work in Process 160,000

b.2. Additional cost is charged to specific job

a.
Work in Process 156,000
Materials 60,000
 Payroll 52,000
Factory Overhead Applied 44,000

b.
Work in Process 8,000
Materials 2,000
Payroll 4,000
Factory Overhead Applied 2,000

c.
Finished Goods 164,000
Work in Process 164,000

C. CLOSURE ACTIVITIES

I. QUESTIONS:

1. List the documents most frequently used in the procurement and use of materials
2. What is the meaning of reorder point
3. what kind of information and data needed to calculate reorder point
4. What is the purpose of EOQ model?
5. What types of cost should be considered in deriving the economic order quantity?
6. What different methods that can be used to account for the sales value of the scrap materials?
7. What are different methods of accounting for defective and spoiled units, respectively?
8. What distinguishes spoiled or defective?
9. How can firm benefit from EOQ and Reorder point technique?
10. What factors should management consider in determining the amount of investment in materials?

PROBLEMS.

IV. SYNTHESIS/ GENERALIZATION

ACCOUNTING FOR BASIC MATERIAL TRANSACTION:

Transaction Business Paper Entry Subsidiary Records

Purchase of Materials Voucher supported by Dr. Materials Received section of
in Advance of Use invoice; receiving Cr. Accounts Payable stock cards
report and purchase
order (PO)
Emergency Purchases Voucher supported by Dr. WP Material Section of
of Direct Materials invoice; receiving Cr. Accounts Payable Cost Sheet
report and purchase
order (PO)
Returns of Materials Return Shipping Order Dr. FOC FOH Ledger
and Supplies to with debit memo Cr. Accounts Payable
vendors
Issue of Direct Materials Requisition Dr. WP Mat. Section of Cost
Materials Cr. Materials Sheet
Issued section of Stock
card
Issue of indirect Materials Requisition Dr. FOC OH Ledger
materials Cr. Materials Issued section of stock
card
Return of excess Returned materials Dr. Materials Issued section of stock
Materials from Factory report Cr. WP cards
Mat. Cost Sheet
V. EVALUATION
The student’s performance will be evaluated as follows:

20% Attendance, Poll Questioning and Oral Exercises

20% Portfolio Journal for work exercises
20% Formative Examination (One online/Offline written quiz covering this specific topic)
40% Summative Examination (This topic is one of the topics included in the Online/Offline Written Examination)
VI. ASSIGNMENT/ AGREEMENT
Research and read about our next topic, Cost and Cost Concepts.

Cabrera,et. al, COST ACCOUNTING AND CONTROL 2018-2019 ed.

De Leon, et. al, COST ACCOUNTING.
VII. REFERENCES Guerrero, COST ACCOUNTING Vol 1.
Rainborn, et. al, Cost Accounting Second ed.
Carter, Cost Accounting 14th Edition

END OF CHAPTER 3