Accounting for Materials

AGENA MARIE SAN PABLO

In manufacturing perspective, we have 3 inventories:

1.Raw materials inventory - are the materials or supplies to be

consumed in the process to be transformed as completed goods.

2. Work in process inventory - are items that are currently in the

process of production.

3. Finished goods inventory - are items that completed the

production process and are held for sale in the ordinary course of
business.
 Flow of Manufacturing Cost
Raw Materials Inventory Work in Process Inventory Finished Goods Inventory
Purchases Direct materials Direct Materials COGM COGM Sold
Indirect materials Direct Labor
FOH Applied

Wages Payable Factory Overhead Cost of Goods Sold

Direct labor FOH applied to Sold
Indirectmaterials production
Indirect labor
Indirect labor
Other FOH costs
 Accounting for Materials
2 Systems of Accounting for Materials Issued to Production and Ending
Materials Inventory:

1. Accounting by the Periodic Inventory System

Under this method the cost of materials issued is not directly determined;
it is indirectly computed by deducting the remaining inventory on hand from
the total available for use.

2. Accounting by the Perpetual Inventory System

Under the perpetual inventory system, both the cost of materials issued
and the ending materials inventory can be directly ascertained after each
transaction.
Control Procedures
The following concepts should be employed in an inventory control system:

1. Inventory - the result of purchasing raw materials and parts.

2. Reduction of inventory - the result of normal use and also finding alternative
uses for scrapping unneeded items.
3. Optimum inventory investment - based on quantitative techniques, which
are designed to minimize the cost of carrying inventory and the cost of
ordering inventory.
4. Efficient purchasing, management, and investment in materials depend on
an accurate forecast of sales and resulting production schedules.
Control Procedures
The following concepts should be employed in an inventory control system:

5. Forecasts help determine when to order materials.

6. Inventory control is more than maintaining invetory records.
7. Methods of inventory will vary depending on the cost of materials and their
importance to the manufacturing procedure.
Commonly used control procedures
• Order Cycling
It is a method where materials on hand are reviewed on a regular or
periodic cycle. The cycle length will differ according to the type of material
being reviewed.

• Min-max Method
This method is based on the assumption that materials inventory have
minimum and maximum levels.
Commonly used control procedures
• Automatic order system
This method is used by most companies that are computerized. An
order is automatically placed when the level of inventory reaches a
predetermined order point quantity.

• ABC Plan
This method is used by companies with a large number of materials,
each one having a different value. The materials control for high-value item
will naturally be different from the material control for a low-value item.
 Material Control
There are two basic aspects of material control

1. Physical control or safeguarding materials

2. Control of the investment in materials

 Phsical control or safeguarding materials
In general, effective control of materials involves:

1. Limited access - only authorized personnel should have access to materials

storage are.

2. Segregation of duties - the following functions should be segregated to

minimize opportunities of misappropriation of inventories - purchasing,
receiving, storage, use, and recording.

3. Accuracy in recording - inventory records should permit the determination

of inventory quantities on hand upon request, and cost records should provide
the data for the valuation of inventories for the preparation of financial
statements.
 Controlling the Investment in Materials
One of the most important objectives of materials control is maintaining the
proper balance of materials on hand.

The planning and control of the materials inventory investment requries

careful study of the following factors: usage of funds, costs of materials
handling, storage, and insurance against fire, theft, or other casualty, loss from
damage, deterioration, and obsolescence.

These factors should be considered in determining (1) when orders should be

placed and (2) how many units should be ordered.
 Order Point
The point at which an item should be ordered, called the order point point
occures when the predeterminedd minimum level of inventory on hand is
reached.

Calculation of the order point is based on the following data:

1. Usage - the anticipated rate at which the materials will be used.
2. Lead time - the estimated time interval between the placement of an order
and receipt of the material.
3. Safety stock - the estimated minimum level of inventory needed to protect
against running out of stock.
 Order Point
Reorder Point = (Average Usage x Normal Lead Time) + Safety Stock

Safety Stock = Change in lead time x Average Usage

 Order Point
Example: Assume that the expected daily usage of an item of material is 100
units, the anticipated lead is 4 days, and it is estimated that a safety stock of
800 units is needed.
 Economic Order Quantity
The purchase order which results in the minimum total inventory cost.

Factors to be considered in determining ordering costs:

1. Salaries and wages of employees engaged in purchasisng, receiving, and
inspecting materials.
2. Communication costs associated with ordering, such as telephone, postage,
and forms of stationery.
3. Materials accounting and recording keeping.
 Economic Order Quantity
The purchase order rwhich results in the minimum total inventory cost.

Factors to be considered in determining carrying costs:

1. Materials storage and handling cost.
2. Interest, insurance, and property taxes.
3. Loss due to theft, deterioration, or obsolescence.
4. Records and supplies associated with the carrying of inventories.
 Economic Order Quantity Formula

EOQ = 2CN
K
where:
EOQ = economic order quantity
C = cost of placing an order
N = number of units required annually
K = annual carrying cost per unit of inventory
Illustration
Number of units of materials required annually 10,000 units
Cost of placing an order P10.00
Annual carrying cost per unit of inventory P0.80

What is the economic order quantity?

Compute for the annual ordering costs and annual carrying costs.
Illustration
The annual required units of an entity is 10,000 units. It was ascertained that
ordering costs amounted to P62.50 per order and the annual carrying cost per
unit amounted to P5.00.

From the given information, answer the following questions:

1. What is the economic order quantity?

2. Compute for the annual ordering costs and annual carrying costs.
Illustration
Christine Products uses 800 units of a product per year on a continuous basis.
The product has carrying costs of P50 per unit per year and order costs of P300
per order.

From the given information, answer the following questions:

1. What is the economic order quantity?

2. Compute for the annual ordering costs and annual carrying costs.
Business papers used to support material
transactions
1. Purchase Requisition - It is a written request, usually sent to inform the
purchasing department of a need for materials or supplies.
Business papers used to support material
transactions
2. Purchase order - It is a written request, to a supplier for specified goods at
an agreed upon price.
Business papers used to support material
transactions
3. Receiving report - when the goods that were ordered are delivered, the receiving
department will unpack and count them. It is interesting to note that the quantity
ordered is not shown on the copy of the purchase order sent to the receving
department.
Business papers used to support material
transactions
4. Materials requisition slip - a written order to the storekeeper to deliver materials or
supplies to the place designated or to issue the materials to the perrson presenting a
properly executed requistion.
 Methods of Costing Materials
The more common methods of costing materials issued and
finished goods sold are:

1. First-in, first-out (FIFO)

2. Average

These methods are related to the flow of costs and not

necessarily to the actual flow of materials or finished goods.
 First-in, first-out
The FIFO method is based on the assumption that cost
should be charged to manufacturing cost or cost of goods
sold in the order in which incurred.
 First-in, first-out
Jan. 1 Beginning balance 20,000 units at P36 P720,000
Jan. 7 Purchase 30,000 units at 37.20 1,116,000
Jan. 12 Issued 36,000 units
Jan. 21 Purchase 48,000 units at 38.00 1,824,000
Jan. 22 Issued 38,000 units
Jan. 29 Purchase 16,000 units at 38.60 617,600

What is the cost of the ending inventory and the cost of materials
issued?
 Average Method
A. Weighted average method
Used for periodic inventory system. This method is based on the
assumption that units issued should be charged at an average cost,
such average being influenced or weighted by the number of units
acquired at each price.
 Weighted Average Method
Jan. 1 Beginning balance 20,000 units at P36 P720,000
Jan. 7 Purchase 30,000 units at 37.20 1,116,000
Jan. 12 Issued 36,000 units
Jan. 21 Purchase 48,000 units at 38.00 1,824,000
Jan. 22 Issued 38,000 units
Jan. 29 Purchase 16,000 units at 38.60 617,600

What is the cost of the ending inventory and the cost of materials
issued?
 Average Method
A. Moving average method
When a perpetual inventory system is used, a new weighted
average unit cost is calculated after each new purchase and this
amount is used to cost each subsequent issuance until another
purchase is made.
 Moving Average Method
Jan. 1 Beginning balance 20,000 units at P36 P720,000
Jan. 7 Purchase 30,000 units at 37.20 1,116,000
Jan. 12 Issued 36,000 units
Jan. 21 Purchase 48,000 units at 38.00 1,824,000
Jan. 22 Issued 38,000 units
Jan. 29 Purchase 16,000 units at 38.60 617,600

What is the cost of the ending inventory and the cost of materials
issued?
 Journal Entries
Raw Materials Inventory xxx
Accounts Payable/Cash xxx
Purchase of raw materials.

Work in Process Inventory xxx

Factory Overhead xxx
Raw Materials Inventory xxx
Issuance of direct and indirect materials to production.
Accounts Payable xxx
Cash xxx
Payment of raw materials to suppliers.
 Special Problems in Material Accounting
1. Discounts

A. Trade Discounts - Trade discounts are not recorded on the books

because purchases are recorded on the books net of the discount.

B. Quantity - Represent cost savings for volume purchases. Like trade

discounts, quantity discounts are not given explicit accounting
recognition in the books.

C. Cash discounts -Granted to customers to motivate them to pay

promptly.
 Special Problems in Material Accounting
1. Freight-in
A. Direct charging - the freight incurred on the purchase of raw
materials is added to the invoice price. The account is debited for the
freight is Materials. The effect is increase in the unit cost.

If two or more materials are purchased and delivered at the same

time, the freight must be allocated using the following methods:
i. Relative peso method
ii. Relative weight method
B. Indirect charging - The freight incurred on the purchase of raw
materials is charged to Factory Overhead Control Account.
 Special Problems in Material Accounting
Illustration
An invoice for raw materials A, B, and C is received from the Bulacan
Corporation. The invoice totals are: A - P25,000; B - P15,000; C -
P10,000. The freight charge on this shipment weighing 10,000 pounds
is P1,500. Shipping weights for the respective materials are 5,000,
2,000, and 1,000 respectively.
Requried:
1. Entry to record the purchase of materials and the freight using
direct charging and indirect charging method.
2. The cost per pound to be entered in the materials ledger cards for
A, B, and C, if freight is allocated using:
a. Relative peso value method
b. Relative weight method