2 - Accounting for Materials, Labor, And Overhead

MODULE 2
Accounting for Materials, Labor and Overhead Costs
This module covers the following learning

objectives:
1. Describe the methods and procedure of

storekeeping, stocktaking and inventory
control.
2. Explain and illustrate the perpetual
inventory system and its procedures
documentation.
3. Explain and illustrate the methods available
for pricing stores issues and for inventory
valuation.
REGISTERED COST ACCOUNTANT 4. Explain the impact of different
remuneration methods on the cost of
finished goods.
5. Explain and illustrate the problems and
procedures of identifying, analyzing,
allocating and absorbing overhead costs.
6. Explain the different bases for overhead
absorption rates.
7. Compute overhead absorption rate.
8. Differentiate and calculate plant-wide
overhead rates and departmental overhead
rates.
9. Explain and illustrate the principles and
methods of treatment of under and over-
absorption of overhead costs.
28 Accounting for Materials, Labor and Overhead Costs Module 2
1.0 ACCOUNTING FOR MATERIALS

1.1 The objectives of material control are as follows:
1.1.1. To provide adequate supply for efficient and uninterrupted operations.
1.1.2. To maintain a minimum investment in materials and supplies.
1.1.3 To avoid loss of time and cost of handling and to protect the company
against any possible loss.
1.2 The total cost of a finished product is composed of the amount spent for
materials, direct labor and share in the factory overhead. It becomes necessary
therefore to adopt a cost control system for each element. The major function, in
general, of any cost control system is to keep expenditures within the limits
provided by a preconceived plan. The control should also encourage cost
reductions by eliminating waste and operational inefficiencies. An effective
system of cost control is designed to control the people responsible for the
expenditures because people control costs, costs do not control themselves.
2.0 MATERIALS CONTROL

2.1 There are two basic aspects of materials control
2.1.1. Physical control or safeguarding materials
2.1.2 Control of the investment in materials
3.0 Physical Control of Materials
3.1 Every business requires a system of internal control that includes procedures for
the safeguarding of assets. Inventories, just like cash and marketable securities,
must be protected from unauthorized use or theft. Inventories usually represent a
significant portion of a manufacturer's current assets and because of _ this,
materials must be controlled from the time the order is placed with the vendor
until they are shipped to customers in the finished form. In general, effective
control of materials involves:
1. Limited access.
2. Segregation of duties.
3. Accuracy in recording.
3.2 Limited Access. Only authorized personnel should have access to materials
storage area. All issuance of materials for use in production and release of
finished goods for shipment should be properly documented and approved.
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Module 2 Accounting for Materials, Labor and Overhead Costs 29
3.3 Segregation of Duties. The following functions should be segregated to

minimize opportunities for misappropriation of inventories: purchasing, receiving,
storage, use, and recording.
3.4 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 preparation of financial statements.
4.0 Controlling the Investment in Materials.
4.1 One of the most important objectives of materials control is maintaining the
proper balance of materials on hand. An inventory of sufficient size and diversity
for efficient operations must be maintained, but the size should not be excessive
in relation to scheduled production needs. The planning and control of the
materials inventory investment requires 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.
4.2 Order Point. A subsidiary ledger must be kept for each individual item of raw
material used in the manufacturing process. This ledger will indicate the
inventory on hand for each item. The point at which an item should be ordered,
called the order point occurs when the predetermined minimum level of inventory
on hand is reached. Calculation of the order point is based on the following data:
1. Usage - the anticipated rage 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.
Assume that the expected daily usage of an item of material is 100 units, the
anticipated lead time is 4 days, and it is estimated that a safety stock of 800 units
is needed. The following calculation shows that the order point is 1,200 units:
100 units (daily usage) x 4 days (lead time) 400 units

Safety stock 800 units
Order point 1,200 units
4.3 Economic Order Quantity. In determining the quantity to be ordered, the cost
of placing an order and the cost of carrying inventory must be considered. Order
costs generally include such factors as:
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1. Salaries and wages of employees engaged in purchasing, receiving, and

inspecting materials.
2. Communication costs associated with ordering, such as telephone, postage,
and forms of stationery.
3. Materials accounting and record keeping.
4.4 Factors to be considered in determining carrying costs typically include:

1. Materials storage and handling costs.
2. Interest, insurance, and property taxes.
3. Loss due to theft, deterioration, or obsolescence.
4. Records and supplies associated with the carrying of inventories.
4.5 METHODS OF COMPUTING ECONOMIC ORDER QUANTITY
4.5.1. TABULAR METHOD —- Under this method, several purchase order

quantity alternatives are listed in separate columns. Total inventory
costs, showing both carrying and ordering costs are calculated for each
alternative. The column with the lowest total amount of inventory cost will
be the economic order ty

4.5.3 FORMULA METHOD -— The formula method is easy to use and it

produces an exact figures. The formula that can be used is:
EQQ = /2xAD x CPO

Nf CCPU
where:
EOQ = economic order quantity
AD = Annual demand
CPO = Cost per order
CCPU = Carrying cost per unit
4.5.4 ILLUSTRATIVE PROBLEM 1

To illustrate the application of the formula, let us assume the following:
Number of units of materials required annually 10,000
Cost of placing an order P 10.00
Annual carrying cost per unit of inventory P
0.80
Using the EOQ formula:
EOQ = 2 (annual demand) (cost per order)

(carrying cost per unit)
2(10,000) (P10)
P0.80
\
P200.000
_—{<>
\Y P0.80
‘|P250,000
500 units

A television manufacturer buys wooden cabinet from outside suppliers at
P 400 per set. Total annual needs are 5,000 units at a rate of 20 sets
per working day. The following cost data are available
Desired annual return on inventory investment (10% x 400) P 40

Rent, insurance, taxes per unit per year 10
Carrying costs per unit per year P_50
Costs per purchase order — clerical costs, supplies,

telephones, etc. P_50

Requirements:
1. What is the economic order quantity?
2. Compute for
a. Annual ordering costs
b. Annual carrying costs
SOLUTION TO ILLUSTRATIVE PROBLEM 2
1. EOQ 2 (annual demand) (cost per order)

(carrying cost per unit)
= 2(P50) (5.000)
\ 50
_ | 500,000
\ P50
s| 10,000
100 units
2. a) Annual ordering cost = 5,000 x50 = P2,500

100
b) Annual carrying cost = 100 x 50 = P 2500

2
4.4 Order Point

4.4.1 Once the Economic Order Quantity has been determined, management
must decide when fo place the order, the order point must be
established. If the lead time and the inventory usage rate are known,
determination of the order point is easy. Lead time is the period
between the placement of the order and the receipt of the materials
ordered. Inventory usage rate is the quantity of materials used in
production over a period of time. The order point should be where the
inventory level reaches the number of units that would be consumed
during the lead time
4.4.2 ILLUSTRAIVE PROBLEM 2

4.5 Safety Stock

4.5.1 Since it is almost impossible to estimate lead time and average usage
rate with accuracy, many companies prefer to carry a safety stock (or
additional inventory) as a cushion against possible stockouts. In such a
case, the order point is computed by adding the safety stock to the
estimate usage during the lead time. A safety stock calculation should
arrive at a figure which properly balances the risk of a stockout against
the additional carrying costs incurred by the extra inventory.

Assume the use of same data as in the computation of the order point
above (without the safety stock), the revised order point may be
computed as follows assuming safety stock of 800 units:
100 units (daily usage) x 4 days (lead time) 400 units

Safety stock 800 units
Revised order point 1,200 units
5.0 BUSINESS PAPERS USED TO SUPPORT MATERIAL

TRANSACTIONS
5.1 PURCHASE REQUISITION - is a written request, usually sent to inform the
purchasing department of a need for materials or supplies. The purchase
requisition is usually preprinted according to the specifications of a particular
company. Most forms usually include the requisition (serially numbered) name of
the department or individual making the request, quantity of items requested,
description of the item, unit price, order data, required delivery date, and
authorized signature.

FIGURE 2.1 PURCHASE REQUISTION
NORTHERN CONSOLIDATED COMPANY

PURCHASE REQUISITION
Department or individual making the request Forming Department
ORDER DATE 1/1/08 DELIVERY DATE REQUESTED 1/03/08
QUANTITY DESCRIPTION UNIT PRICE TOTAL

600 UNITS MATERIAL A P 5.50 P 3,300
TOTAL COST P3,300

APPROVED BY
Using the Illustrative problem of Chapter 4, the Forming Department

requisitioned 600 units of Materials A. Two copies of the purchase requisition
are customarily made, the original going to the purchasing department (to place
the order) and the copy remaining with the storeroom clerk who requested the
purchase order (to keep track of orders placed)
5.2 PURCHASE ORDER - is a written request to a supplier for specified goods at an

agreed upon price. The request also stipulates terms of delivery and terms of
payment. The purchase order is the supplier's authorization to deliver goods and
submit a bill. All items purchased by a company should be accompanied by
purchase orders, which are serially numbered to provide control over their
issuance. The following items commonly included in a purchase order are
preprinted name and address of company placing the order, purchase order
number, name and address of supplier, order date, date delivery is requested,
delivery and payment terms, quantity of items ordered, description, unit and total
price, shipping, handling, insurance and related costs, total cost of entire order,
and authorized signature.
If the purchase requisition is properly completed, the purchasing department will

issue a purchase order ( in this case, for 600 units of Material A ). Figure 6-2
below shows a purchase order. The original is sent to the supplier (to place the
order) copies usually go to the accounting department (for future recognition in
the purchases journal and the general and subsidiary ledgers), to accounts
payable , (for eventual payment within the discount period), to the receiving
department (to alert them to expect a delivery), and a copy is kept by the
purchasing department (to maintain a file of all purchase orders issued)

FIGURE 2.2 PURCHASE ORDER

NOVALICHES, QUEZON CITY
SUPPLIER: Ellery Company Cubao, Q. C ORDER DATE ~— 1/02/08
DELIVERY TERMS _ FOB Terms PAYMENT TERMS n/30
QUANTITY DESCRIPTION UNIT PRICE TOTAL

600 UNITS MATERIAL A P 5.50 P 3,300
TOTAL COST P3,300

APPROVED BY
5.3 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
receiving department. This deliberate omission ensures that the goods delivered
are actually counted. The goods are checked to be sure that they are not
damaged and that they meet the specifications of the purchase order. This form
includes the suppliers name, purchase order number, date delivery was
received, quantity received, description of goods, discrepancies from the
purchase order (or mention of damaged goods, and authorized signature
FIGURE 2.3 RECEIVING REPORT

NOVALICHES, QUEZON CITY
SUPPLIER: Ellery Company
PURCHASE ORDER NO. 015

DATE RECEIVED 1/03/08
QUANTITY DESCRIPTION DISCREPANCIES

600 MATERIAL A None
AUTHORIZED SIGNATURE

The original copy of the receiving report is kept by the receiving department.
Copies are sent to the purchasing department (to indicate the order was
received) and to the accounts payable department (to be matched against the
purchase order and the supplier's bill). If all three agree, payment is authorized.
Copies are also sent to the accounting department (to journalize and post the
purchase and the related liability) and to the storeroom clerk who originated the
purchase requisition (to give notice that the goods have arrived). A copy also
accompanies the materials to the storeroom.
5.4. 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
person presenting a properly executed requisition. Each material requisition form
shows the job number or department requesting the goods, their quantity and
description, and the unit cost and total cost of the goods issued. The cost that is
entered on the materials requisition is the amount charged to production for
materials consumed.
FIGURE 2.4 MATERIALS REQUISITION FORM
MATERIAL REQUISITION FORM
DATE REQUISITIONED: 1/03/08 DATE ISSUED 1/06/08
DEPARTMENT REQUISITIONING Forming APPROVED BY
REQUISITIONNO 05 ISSUED BY
QUANTITY DESCRIPTION JOB NO. UNIT COST TOTAL

200 Material A 101 P 5.00 P1,000
400 Material A 102 5.00 2,000
200 Material A 102 5.50 1,100
TOTAL P4,100
6.0 METHODS OF COSTING MATERIALS

6.1 The main objective of cost accounting is to produce accurate and meaningful
figures for the goods manufactured and sold which are to be used by
management for control, analysis and for the determination of the of the
operating income.

6.2 The more common methods of costing materials issued and finished goods sold
are:
1. First-in, first-out (FIFO)
2. Average cost
6.3 These methods are related to the flow of costs and not necessarily to the actual
flow of materials or finished goods. If only the materials were acquired at the
same cost all year round, then valuation of materials inventory, end, will not be a
problem because the value can be computed by simply multiplying the units on
hand and the unit cost. The same can be said for the finished goods because if
the units were produced at the same cost all year round, the value at the end of
the period can be computed by multiplying the finished goods on hand by the
cost to produce each unit. The different methods are used because the materials
are acquired at different costs during the year. Average cost for perpetual
inventory system refers to moving average and for periodic inventory system -
weighted average.
6.4 FIRST-IN, FIRST-OUT (FIFO) METHOD OF COSTING
The first-in, first-out (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. Inventories are stated in terms of the most recent costs and expense is
charged with the earliest costs incurred.
Illustrative problem:
August 1 Inventory 400 units at P10 P 4,000
12 Purchase 600 units at P12 7,200
16 Issue 500 units
20 Issue 200 units
28 Issue 400 units
The inventory on August 31 shows 600 units on hand. Under periodic inventory
system, the most recent costs would be assigned to the units as follows:
From Aug. 25 purchase 400 units at 14 P 5,600
From Aug. 18 purchase 200 units at 15 3,000
Total 600 P 8.600
If the ending inventory is valued at P8,600, cost of materials issued is P12,700
computed as follows:

Materials, Aug. 1 P 4,000

Purchases (7,200 + 4,500 + 5,600) 17,300
Total available for use 21,300
Less: Materials, Aug. 31 8,600
Direct materials used P12,700
When perpetual inventory system is used, a stock card is used to record the
costs assigned to units issued and to cost relating to the units on hand.
DATE RECEIVED ISSUED BALANCE

8/1 400 atP10.00 P4,000
12 600 at P12.00 400 at 10.00 4,000
600 at 12.00 7,200
16 400 at 10.00
100 at 12.00 500 at 12.00 6,000
18 300 at P15.00 500 at 12.00 6,000
300 at 15.00 4,500
20 200 at 12.00 300 at 12.00 3,600
300 at 15.00 4,500
25 400 at P14.00 300 at 12.00 3,600
300 at 15.00 4,500
400 at 14.00 5,600
28 300 at 12.00 200 at 15.00 3,000
100 at 15.00 400 at 14.00 5,600
As shown on the issued section of the stockcard on page 155, the cost of
materials issued is:
400 at P10.00 P 4,000
100 at 12.00 1,200
200 at 12.00 2,400
300 at 12.00 3,600
100 at 15.00 1.500
1,100 P 12,700
The value of the units on hand, August 31 using perpetual inventory system is
the same as that computed under period inventory system. The amount is
computed as follows:
200 at P15.00 P 3,000
400 at 14.00 5.600
600 P.8.600

6.5 AVERAGE METHOD

6.5.1 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. The inventory at the end is
computed by multiplying the weighted average cost per unit by the units
on hand. Using the illustrative problem on page 56, the weighted
average unit cost is computed as follows:
400 units at P 10.00 P 4,000
600 units at 12.00 7,200
300 units at 15.00 4,500
400 units at 14.00 5,600
1.700 P 21,300
Weighted averaged unit cost = 21,300

1,700
= P 12.529
Inventory, August 31 (600 units x P 12.529) = P 7,517.65
6.5.2. 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.
DATE RECEIVED ISSUED BALANCE

8/1 400 atP10.00 P 4,000
12 600 at P12.00 1,000 at 11.20 11,200
16 500 at P11.20 500 at 11.20 5,600
18 300 at 15.00 600 at 12.625 10,100
20 200 at_ 12.625 600 at 12.635 7,575
25 400 at_ 14.00 1,000 at 13.175 13,175
28 400 at_ 13.175 600 at 13.175 7,905
The computation of the unit cost is as follows:

Aug. 12
Balance 400 at P10.00 P 4,000
Purchase 600 at 12.00 7,200
1,000 P11,200

The new weighted average unit cost pe P_ 11,200

ee a
1,000 units
11.2
io
~
Aug. 18
Balance 500 at P11.20 P 5,600
Purchase 300 at 15.00 4,500
P_10,100
The new weighted average unit cost P 10,100

800 units
P 12.625
The cost of materials issued may be computed from the data presented
under issued section.
500 units at P 11.20 P 5,600

200 units at 2,/25
400 units at 5,270
—_—-is
1.100 P13,395
6.6 COMPARISON - FIFO AND AVERAGE METHODS
FIFO AVERAGE
Inventory P 4,000 P 4,000
Purchases 17,300
Total available for use 21,300
Less: Inventory, Aug. 31 7,905
Direct materials used P13,395
6.7 SPECIAL PROBLEMS IN MATERIAL ACCOUNTING

6.7.1. DISCOUNTS - constitute a reduction in the list price.
1. Trade discounts - generally given in terms of percentage (15%, 10%,
5%) and are used to convert single price list into a series of price lists for
different types of middleman. Trade discounts are not recorded on the
books because purchases are recorded on the books net of the discount.
Illustrative problem
Windy Corporation buys all of it materials and supplies from the Oregon Company and is
allowed a trade discount of 10%. Purchases during the month were P400,000 before the
discount.

The entry to record the purchase is:

Materials P 360,000
Accounts Payable P 360,000
(400,000 x 90%)
2. Quantity discounts - represent cost savings for volume purchases.

Like trade discounts, quantity discounts are not given explicit accounting
recognition in the books.
3. Cash discounts - granted to customers to motivate them to pay
promptly.
a) When taken method - purchases and liabilities are recorded at
gross amounts at the time of purchase. The discount is only
recognized when the account is paid within the discount period.
b) When not taken method - purchases and liabilities are recorded
at net at the time of purchase; when payment is made after the
lapse of the discount period, the discount not availed of is
charged to a “Purchase Discount Lost” account. It is called when
not taken method because even if the account is paid within the
discount period, no “Purchase Discount” is recorded and
therefore readers of the financial statements would not know that
the company has availed of the discount.
c) When offered method - purchases are recorded at net and the
liability is recorded at gross, the difference is charged to an
“Allowance for Purchase Discount” account. When payment is
made after the lapse of the discount period, the discount not
availed of is charged to the “Purchase Discount Lost” account.
Illustrative Problem:
The Jenelle Company purchased materials listed at P40,000; terms, 2/15, n/30 on August
1.
Assume payments as follows:
a) Full payment is made on August 14.
b) Full payment is made on August 30.
Requirements: Entries to record the purchase and payments assuming:

1) When taken method is used.
2) When not taken method is used.
3) When offered method is used.
1.0 When taken method is used:
Aug. 1 Materials 40,000

Accounts Payable 40,000

14 Accounts Payable 40,000

Purchase Discount 800
Cash 39,200

Cash 40,000
2.0 When not taken method is used:


Cash 39,200

Purchase Discount Lost 800
Cash 40,000
3.0 When offered method is used:

Allow for Purchase Discount 800

Allow. For Purchase Discount 800
Cash 39,200

Purchase Discount Lost 800
Allow. for Purchase Discount 800
Cash 40,000
FREIGHT-IN
io
fe
in
Direct charging - the freight incurred on the purchase of raw materials is

|
added to the invoice price. The account debited for the freight is
Materials. The effect is an 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:
a. Relative peso value method - freight is allocated on the basis of the
peso value of the items purchased. This is used for materials
purchased and expressed in different terms of measurement.

b. Relative weight method - freight is allocated on the basis of the

weight of the items purchased.
2. Indirect charging - the freight incurred on the purchase of raw materials

is charged to Factory Overhead Control account.
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.
Required:
1. Entry to record the purchase of materials and the freight using:
a. Direct charging method.
b. 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.
1. a) Direct charging method:
Materials 51,500
b) Indirect charging method:
Materials 50,000
Factory Overhead Control 1,500
2. a) Relative peso value method:
Share in Total Total Cost per

Mat. Invoice Percentage Freight Cost Pound
A 25,000 3% 750 25,750 5.15

B 15,000 3% 450 15,450 7.725
Cc 10,000 3% 300 10,300 10.30
50,000 1,500 51,500

Allocation Rate:
1,500 = 3%
50,000
b) Relative weight method
Weight Freight per Sharein_ Total Cost per

Mat. (pounds) _ Pound freight Cost Pound
A 5,000 0.1875 937.50 25,937.50 5.1875
B 2,000 0.1875 375.00 15,375.00 7.6875
Cc 1,000 0.1875 187.50 10,187.50 10.1875
8,000 1,500.00 51,500.00
Allocation Rate:
1,500
8,000 = 0.1875
6.8 SPOILED AND DEFECTIVE MATERIALS

6.8.1 Spoiled materials are completed goods which in the process of
manufacture have developed some imperfection which cannot be
economically corrected and thus the goods may be sold as seconds.
6.8.2 Defective materials are completed goods which in the process of

manufacture have developed some imperfections for which unlike
spoiled materials, can, by the expenditure of additional labor, and
possibly materials, be made into perfect finished articles.
6.9 TWO METHODS OF ACCOUNTING FOR SPOILED MATERIALS
The method to account for spoiled materials depends on the reason for such spoilage.
1. Charged to the specific job - this method is used if the reason for the 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 remaining perfect finished articles in the job.
Entry: Spoiled goods XXX

Work in process XXX
The amount debited to spoiled goods and credited to work in process is equal to
the number of units spoiled multiplied by the estimated sales value per unit.
2. Charged to all production - 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. With this method, all units manufactured during the period are
charged with an additional cost which is added to the factory overhead rate. The

unit cost originally charged will not increase anymore even if there are spoiled
units discovered later on.
Entry: Spoiled goods XXX

Factory overhead control XXX
Work in process XXX
The amount debited to spoiled goods is equal to the number of units spoiled
multiplied by the estimated sales value per unit. The amount credited to work in
process is equal to the total costs incurred/charged to the spoiled units. The loss
is charged to factory overhead control.
If the number of units spoiled exceed the limit set by the company, or if the
reason is not considered normal to the process, the loss on the spoiled units is
charged to a loss account.
Job 3044 called for the making of 4,000 with these unit costs:
Direct materials P 15.00
Direct labor 13.00
Factory overhead (includes a P1.00
Allowance for spoiled work) 12.00
Total P 40.00
When the order was completed, 200 rejected units, a normal number, were sold
for P18.00 each.
Required:
1. Entries if the loss is charged to all production.
2. Entries if the loss is charged to the specific job.
1. Loss is charged to all production:

a) Work in Process 160,000
Materials 60,000
Payroll 52,000
Factory Overhead Applied 48,000
Materials = 4,000 x 15.00
Labor = 4,000 x 13.00
Overhead = 4,000 x 12.00
b) Spoiled Goods 3,600

Factory Overhead Control 4,400
Work in Process 8,000
Spoiled = 200 x 18.00
WP = 200 x 40.00

c) Finished Goods 152,000

2. Loss is charged to the specific job.

Materials 60,000
Payroll 52,000
Materials = 4,000 x 15.00
Labor = 4,000 x 13.00
Overhead = 4,000 x 11.00
b) Spoiled Goods 3,600


Under the method, loss charged to all production, the unit cost of the completed
units remains at P40.00. In spite of the spoiled units, the unit cost remained the
same because the increase was made at the start (when P1.00 was added to the
factory overhead rate as allowance for spoiled work). All units processed during
the period, even those jobs without spoiled units, will absorb the additional P1.00.
Upon completion of the job, even if there were spoiled units, the unit cost will be
the same as the amount originally charged to the job.
On the other hand, under the method, loss charged to the specific job, it will be
noted that the factory overhead rate was recorded at the original amount P11.00
(allowance of P1.00 for spoiled work was not added). The remaining perfect units
in the job will absorb the loss on the spoiled, resulting in an increase in the unit
cost
(152,400 / 3,800 units = 40.105/unit)
the increase in the unit cost (40.105 - 39.00 = 1.105) may be computed as
follows:
Cost of spoiled (200 x 39.00) 7,800
Less: Amount recovered from sale (200x18) 3,800
Loss on spoiled goods 4,800
The loss on spoiled goods will be absorbed by the remaining good units (4,200
divided by 4,800 units = 1.105/unit).

6.10 TWO METHODS OF ACCOUNTING FOR DEFECTIVE MATERIALS
The accounting problem for defective units is the additional costs to be incurred in
reprocessing the units to convert them into perfect articles. There are two methods
available:
1. Charged to the specific job - 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.
Entry: Work in process XXX

Materials XXX
Payroll XXX
Factory Overhead Applied XXX
2. Charged to all production - if the reason is normal to the process and the number
of defective units does not exceed the normal limit, then the additional costs
incurred will be charged to all units being processed during the period.
Entry: Factory overhead control XXX

Materials XXX
Payroll XXX
Factory overhead applied XXX
Job 3044 called for the making of 4,000 units with these unit costs:
Direct materials P 15.00

Direct labor 13.00
Factory overhead (includes a P1.00
Allowance for defective units) 12.00
Total P_ 40.00
During processing 300 units were found to be defective and required the following total
additional costs: materials - P2, 000; labor - P4, 000; and overhead - P2,000.
Required:
1. Entries if the additional cost is charged to all production.
2. Entries if the additional cost is charged to the specific job.
1. Additional cost is charged to all production.

Materials 80,000
Payroll 52,000

b) Factory Overhead Control 8,000

Materials 2,000
Payroll 4,000
c) Finished goods 160,000

The cost of the finished goods will remain at the original amount charged to the job
(160,000 divided by 4,000 units = P40.00)
Additional cost is charged to the specific job.

Materials 80,000
Payroll 52,000
b) Work in Process 8,000

Materials 2,000
Payroll 4,000

The unit cost of the completed units increased from the original P39.00 to P41.00
(164,000 divided by 4,000 units). All units in the job will share in the cost incurred to re-
process the defective units.
6.11 SCRAP
These are salable materials arising from the primary manufacturing operations. The
expected sales value of the scrap produced by the manufacturing process determines the
accounting procedures to be used. When the scrap value is small, no entry is made for
the scrap until it is sold. The entry upon the sale is:
Cash/Accounts Receivable XXX

Scrap Revenue XXX
The income from scrap sales is usually reported as “Other Income’ in the income
statement.

If the value of the scrap is relatively high, an inventory card should be prepared, and the
scrap transferred to a controlled materials storage area. If both the quantity and the
market value of the scrap are known, the following methods may be used.
6.11.1 THREE METHODS OF ACCOUNTING FOR SCRAP
1. If the scrap recovered can be traced to a specific job, the entry is:
Scrap/Scrap Materials XXX

Work in Process XXX
The amount recovered for the scrap will be entered negative ( ) on the materials
section of the job order cost sheet.
2. Ifthe scrap recovered are not traceable to a specific job, the entry is:
Miscellaneous Income XXX
3. Ifthe scrap recovered are from factory supplies and indirect materials, the entry is:
Factory overhead control XXX
6.12 SUMMARY OF ACCOUNTING FOR BASIC MATERIAL TRANSACTION
SUBSIDIARY
TRANSACTION BUSINESS PAPER ENTRY RECORDS
Purchases of Voucher supported Dr. Materials Received
Materials in by invoice; Cr. Accounts section of
Advance of use receiving report and Payable stock card
purchase order (PO)
Emergency Voucher supported Dr. WP Material section
Purchases of by invoice; Cr. Accounts of cost sheet
Direct material receiving report & PO Payable
Emergency Voucher supported Dr. FOC Factory OH
Purchases of by invoice; Cr. Accounts ledger
ind. Materials receiving report & PO Payable
Return of Return shipping Dr. Accounts Received section
Materials and order with debit Payable of stock card ()
Supplies to vendor | memo Cr. Materials
Issue of Materials Dr. WP Material section
Direct materials requisition Cr. Materials of cost sheet
Issued section
of stock card
Issue of indirect Materials Dr. FOC OH ledger

Mat. & supplies requisition Cr. Materials Issued section

stock card
Return of excess Returned Dr. Materials Issued section
Materials from materials report Cr. WP of stock card ()
Factory Material cost Sheet
7.0 ACCOUNTING FOR FACTORY OVERHEAD

All costs incurred in the factory that is not direct materials or direct labor is
generally termed as factory overhead. One method to determine whether factory
expenditure is a factory overhead item is to company it to the classification
standard established for direct materials and direct labor costs. If the expenditure
cannot be charged to either of these two “direct” factory accounts, it is classified
as factory overhead.
7.1 CLASSIFICATION OF OVERHEAD

Indirect materials
weno
Indirect labor
Indirect expenses - all items of manufacturing overhead not classifiable as
indirect materials or indirect labor.
7.2 BUDGETING FACTORY OVERHEAD COSTS
Budgets are management's operating plans expressed in quantitative terms,

such as units of production and related costs. After factory overhead costs have
been classified as either fixed, or variable, budgets can be prepared for expected
levels of production. The separation of fixed and variable cost components
permits the company to prepare a flexible budget.
7.3 FACTORS TO BE CONSIDERED IN THE COMPUTATION OF OVERHEAD

RATE
BASE TO BE USED
Physical output
Direct materials cost
ooo”
Direct labor cost

Direct labor hours
Machine hours
2, ACTIVITY LEVEL TO USE

a. Normal capacity
b. Expected actual capacity

3. INCLUSION OR EXCLUSION OF FIXED FACTORY OVERHEAD

a. Absorption costing - method used for cost accounting
b. Direct costing - method used for internal reporting (management services)
4. USE OF SINGLE RATE OR SEVERAL RATES

a. Plant-wide or blanket rate - one rate for all producing departments
b. Departmentalized rate - one rate for each producing department.
7.4 BASE TO BE USED
The base to be used should be related to functions represented by the overhead

cost being applied. If factory overhead is labor - oriented, the most appropriate
base to use is direct labor hours or direct labor cost. If factory is investment-
oriented, related to operation of machinery, then the most appropriate base will
be machine hours. On the other hand, if factory overhead is material-oriented,
then material cost might be considered as the most appropriate base. The
simplest of all bases is physical output or units of production.
ILLUSTRATIVE PROBLEM
SOLUTION TO ILLUSTRATIVE PROBLEM

a. Factory overhead rate = Est. factory overhead
Est. direct mat. cost
= piP 450,000
ds
P 600,000
= 75% of direct mat. cost

b. Factory overhead rate Est. factory overhead

Est. units of production
= P 450,000
90,000 direct labor hours
P5.00/unit
c. Factory overhead rate Est. factory overhead

Est. machine hours
= P 450,000
—S—S Es
45,000 machine hours
= P_10.00/machine hour
d. Factory overhead rate Est. factory overhead

Est. direct labor cost
= P_450.000
—_—<—$£_=€=$_—=_=_>_>“>
P 300,000
= P 150% of direct labor cost
e. Factory overhead rate Est. factory overhead

Est. direct labor hours
= P_450.000
—<£_=—=—___
100,000 direct labor hours
= P 4.50/direct labor hour
The rate computed above is known as the plant-wide or blanket rate. All
departments in the company will use the same application rate for factory
overhead and also the same base. Some companies, however, prefer to
compute factory overhead on a departmentalized basis. The use of
departmentalized rates will improve the charging of overhead to jobs and
products.
7.5 STEPS IN COMPUTATION OF DEPARTMENTALIZED OVERHEAD RATE

1. Divide the company into segments, called departments, cost centers, to
which expenses are charged.
2. Estimate the factory overhead for each department (direct departmental
charges + indirect departmental charges).

Select and estimate the base to be used by each department.

oe we
Allocate the service department costs to the producing departments.

Compute the factory overhead rate (similar to computation using blanket
rate).
In a departmentalized company, factory overhead should be budgeted for each

department. The procedures for distributing the budgeted departmental
expenses are identical to those used to allocate the actual factory overhead
expenses. Prior to the computation of the departmentalized factory overhead
rate, management must make sure that the service department costs have been
allocated to the producing departments. Departmentalized overhead rates are
for the producing departments only. Producing departments, which include the
production lines, are the cost-accumulation centers in which work is performed
directly on the goods being produced. On the other hand, service departments,
which include such activities as maintenance, personnel, employee services, and
the provision of heat, power, and light, are necessary for the entire factory -
including the producing departments - to remain in operation.
7.6 TYPICAL ALLOCATION BASES FOR COMMON COSTS
Most common costs can be grouped into four:

1. Labor-related common costs
2. Machine-related common costs
3. Space-related common costs
4. Service-related common costs
Common costs should be analyzed carefully to determine the most appropriate

allocation base. The typical allocation bases for common costs are:
COMMON COST TYPICAL ALLOCATION BASE

Labor-related
1. Supervision Number of employees, payroll amount
or labor hours
2. Personnel services Number of employees
Machine-related
3. Insurance on equipment Value of equipment
4. Taxes on equipment Value of equipment
5. Equipment depreciation Machine-hours, equipment value
6. Equipment maintenance Number of machines, machine hours
Space-related
7. Building rental Space occupied
8. Building insurance Space occupied

9. Heat & air-conditioning Space occupied, volume occupied

10. Concession rental Space occupied & desirability of location
11. Interior bldg. maintenance Space occupied
Service-related
12. Material handling Quantity or value of materials
13. Billing and accounting Number of documents
14. Indirect materials Value of direct materials
7.7 METHODS OF ALLOCATING SERVICE DEPARTMENT COST TO

PRODUCING DEPARTMENTS
L. Direct method - the most widely used method. This method ignores
any service rendered by one service department to another, it allocates
each service department’s total cost directly to the producing
departments.
Step method - sometimes called sequential method of allocation. This
method recognizes services rendered by service departments to other
service departments and is more complicated because it requires a
sequence of allocation. The sequence typically starts with the
department that renders service to the greatest number of other service
departments and ends with the department that renders service to the
least number of other departments. Once a service department’s costs
are allocated, no subsequent service department costs are allocated to
it.
Algebraic method - sometimes called reciprocal method. This method
Ww
allocates costs by explicitly including the mutual services rendered

among all departments.
ILLUSTRATIVE PROBLEM
Kappa Gamma Company’s factory is divided into four departments - producing
departments; Molding and Decorating, serviced by the Buildings and Grounds and the
Factory Administration departments. Buildings and Grounds cost will be allocated using
square feet (floor area) and Factory Administration cost will be allocated using direct
labor hours. In computing predetermined overhead rates, machine hours are used as the
base in Molding and direct labor hours as the base in Decorating.
Bldgs. & Factory
Molding Decorating Grounds Adm.
Budgeted FO P400,000 P600,000 P80,000 P120,000
Direct labor hours 200,000 100,000
Machine hours 100,000 60,000 2,000 4,000

Requirements: Allocate the cost of the service departments using:

1. Direct method
2. Step method - start with Bldgs. & Grounds
3. Algebraic method
SOLUTION TO ILLUSTRATIVE PROBLEM

1. Direct method
Molding Decorating B&G FA
Budgeted FO P400,000 P600,000 P80,000 P120,000
Allocated FO
B&G 50,000 30,000 (80,000)
FA 80,000 40,000 (120,000)
Total FO P530,000 P670,000
Base 200,.000MH 100,000DLH
FOH Rate P.2.65/MH P_5.70/DLH
Allocation of B & G cost

Molding = 100 x 80,000
160
Decorating = _60 x 80,000
160
Allocation of FA cost
Molding = 200 x 120,000
300
Decorating = 100 x 120,000
300
2. Step method
Budgeted FO P400,000 P600,000 P80,000 P120,000
Allocated FO
B&G 48,781 29,268 (80,000) 1,951
FA 81,301 40,650 (121,951)
Total FO P530, 082 P669, 918
Base 200,000 MH 100,000 DLH
FO Rate P2.65/MHrs P6.70/DLH
Allocation of B & G cost

Molding = 100 x 80,000
164
Decorating = _60 x 80,000
164
FA = _4 x 80,000
164

3. Algebraic method
Additional information for the illustrative problem:
Services provided by
B&G FA
Molding 50% 40%
Decorating 30% 50%
B&G - 10%
FA 20% -
Algebraic equation:
B&G = 80,000 + 10% (FA)
FA = 120,000 + 20% (BG)
Substitution:
B&G = 80,000 + 10% (120,000 + .20BG)
= 80,000 + 12,000 + .02BG

.8BG = 92,000
BG = 92,000
.98
= 93,878
FA = 120,000 + 20 %( BG)
= 120,000 + 20 %( 93,878)
= 138,776
The allocation will be as follows:

Budgeted FO P400,000 P600,000 P80,000 P120,000
Allocated FO
B&G 46,939 28,163 (93,878) 18,776
FA 55,510 69,388 13,878 (138,776)
Total FO P502,.449 P697,551
7.8 CAPACITY PRODUCTION
In the estimation of manufacturing overhead, as well as the estimation of the

base to be used for allocation, it is important to determine what capacity of
production should be adopted.
a. Theoretical, maximum or ideal capacity - a capacity to produce at full
speed without interruptions. It does not give allowance for human and
machine errors neither does it give allowance for any circumstances that

might result to a stoppage of production within or not within the control of

management.
b. Practical capacity - a capacity of production that provides allowance for
circumstances that might result to stoppage of production.
Cc. Expected actual capacity - a capacity concept based on a short range
outlook which is feasible only for firms whose products are seasonal or
where the market and style changes allow price adjustments according
to competitive conditions and customer demands.
d. Normal capacity - a capacity of production taking into consideration the
utilization of the plant facilities to meet commercial demands served over
a period long enough to level out the peaks and valleys which come with
seasonal and cyclical variations. This capacity is commonly used in the
computations of overhead rates.
7.10 METHOD OF ACCUMULATION OF FACTORY OVERHEAD COSTS

1. Non-controlling account system - an account for each kind of overhead
expense according to their nature is opened in the ledger and charges to
such account are made upon incurrence of the expense.
2. Controlling account system - an Overhead Control account is opened in the
general ledger wherein the overhead incurred are charged and a subsidiary
ledger is maintained to show in detail the nature and account of the expense.
Computation of overhead chargeable to individual cost sheets
Actual factor incurred per cost sheet x predetermined overhead rate
Entry to charge production with applied overhead:
Work in process - overhead XXX

Factory overhead applied XXX
Factory overhead variance - the difference between the actual factory overhead as
shown by factory overhead control account and the overhead charged to production as
shown by the factory overhead applied account.
Classification of manufacturing overhead variance

a. Underapplied overhead - the difference between actual overhead and applied
overhead when the actual is more than the applied.
b. Overapplied overhead - the difference between actual overhead and applied
overhead when the actual is less than the applied.

Causes of the manufacturing overhead variance:

a. Spending variance - the variance due to expense factors.
b. Idle capacity or volume variance - the variance due to difference in volume and
activity factors.
Analysis of manufacturing overhead variance

a. Spending variance
Actual factory overhead incurred P XXX
Less: Budget allowed based on capacity used
Fixed factory overhead P XXX
Variable factory overhead XXX XXX
Spending variance P XXX
b. Idle capacity variance
Budget allowed based on capacity used P XXX
Less: Factory overhead applied XXX
Idle capacity variance P XXX
Accounting for overhead variance

a. During the period prior to the closing of the books, the overhead variance is not
recognized in the account and the actual factory overhead account as well as the
applied factory overhead accounts is kept open. When interim financial statements
are prepared and the variance is expected to be absorbed prior to year-end, such
variance should be deferred rather than disposed of immediately.
b. At the end of the accounting period

1. Ifthe amount of the overhead variance is immaterial or it is established to be the
result of inefficiency, it is closed to cost of goods sold.
2. Ifthe amount of the overhead variance is materials and found to be the result of
an erroneous computation of the predetermined overhead rate, such variance is
distributed to the cost of goods sold, finished goods inventory, and the work in
process inventory.
Computation of factory overhead variance

The Davidson Corporation made the following data available from its accounting records
and reports.
Budgeted factory overhead
P900,000
Budgeted direct labor hours
100,000 hrs.
Variable factory overhead rate P 1.00/DLHr.
Actual factory overhead P350, 000
Actual direct labor hours used 110,000 hrs.

Solution:
Spending variance:
Actual factory overhead P350, 000
Budget allowed on actual hours
Fixed P200, 000
Variance 110,000 310,000
Spending variance - unfavorable P 40,000
Idle capacity variance:

Budget allowed on actual hours P310, 000
Applied factory OH (110,000 x P3.00) 330,000
Idle capacity variance - favorable P(20,000)
To understand fully the computation of the variance, the following table may be prepared:
Total Per Hour
Fixed overhead P 200,000 P 2.00
Variable overhead 100,000 1.00
Total P.300,000 P.3.00
Factory overhead rate = 300,000

100,000 hrs.
= P_3.00/DLHr.
Variable overhead cost 100,000 Hrs. x P 1.00

P 100,000
8.0 ACCOUNTING FOR LABOR

Factory payroll costs are divided into - a) direct labor, and b) indirect labor.
Direct labor represents payroll costs that are allocated directly to the product and
is debited to the work in process account. Indirect labor costs of labor costs
incurred for a variety of jobs that are related to the production process but are
considered either too remote or too insignificant to be charged directly to
production. Indirect labor costs are charged to the factory overhead control
account. Included as indirect labor are: salaries and wages of the factory
superintendent, supervisors, janitors, clerks, factory accountants, and
timekeepers.
The accounting system of a manufacturer must include the following procedures

for recording payroll costs.
1. Recording the numbers of hours used in total and by job.
Recording the quantity produced by the workers.
wr
Analyzing the hours used by employees to determine how time is to be

charged.

4. Allocation of payroll costs to jobs and factory overhead accounts.

5. Preparation of the payroll, including computation and recording of the
employees gross earnings, deductions, and net earnings.
8.1 WAGE PLANS

There are different wage plans that are being used by companies. The plan
established by management is approved by the union and should comply with
regulations of government agencies. Some of these plans are: hourly-rate plan,
piece-rate plan, and modified wage plan.
Hourly-Rate Plan
Under this plan, a definite rate per hour is set for each employee. An employee’s
wages are calculated by multiplying the rate per hour by the number of hours
worked. The hourly-rate plan is simple to use but does not provide incentive for
the employee to achieve a high level of productivity. The employee is paid for
merely “being on the job.”
Piece-Rate Plan
Under a piece-rate plan, earnings are calculated by multiplying the employee’s

output by the rate per piece. The plan provides an incentive for the employee to
produce more. However, the employee might sacrifice quality to maximize
eamings.
Modified Wage Plan
This plan combines the features of hourly-rate and piece-rate plans. An example
of a modified wage plan would be to set a minimum hourly wage that will be paid
by the company even if an established quota of production is not attained by an
employee. Ifthe established quota is exceeded, an additional payment per piece
would be added to the minimum wage level.
8.3 CONTROLLING LABOR COST

Maintaining labor records is the responsibility of the time-keeping and payroll
departments. The time-keeping department accounts for the time spent by the
employees in factory.
The payroll department computes each employee’s gross earnings, the amount
of withholdings and deductions, and the net earnings to be paid to the employee.
The departmental responsibilities of time-keeping and payroll are carried out by

completing and maintaining the following forms and records:

Time-keeping Payroll
Clock cards Payroll records
Time tickets Employee’s earning records
Production reports Payroll summaries
8.4 ACCOUNTING FOR LABOR COSTS

For all regular hourly employees, the hours worked should be recorded on a time
ticket or individual production report. The time ticket shows the employee’s
starting and stopping time on each job, the rate of pay, and the amount of
earnings. Individual production reports are used instead of time tickets when
labor costs are calculated using piece rates. The time tickets and production
reports are sent to payroll on a daily basis. The pay rates and gross earnings are
entered, and the reports are forwarded to accounting. Cost accountants sort the
time tickets and production reports and charge the labor costs to the appropriate
jobs or department and factory overhead. The accounting department records
the earnings in factory overhead ledger and on the labor cost summary.
The labor cost summary is used as the source for making a general journal entry
to distribute payroll to the appropriate accounts. The entry is then posted to the
control accounts, Work in Process and Factory Overhead in the general ledger.
In preparing the labor cost summary from the tickets, it is important to separate
any overtime from an employee’s regular time because the accounting treatment
may be different for each type of pay. Regular time worked is charged to job
debiting Work in Process. Overtime may be charged to jobs, to factory
overhead, or allocated partly to jobs and partly to overhead. Overtime
distribution depends upon the conditions creating the need for overtime hours.
If an employee works beyond the regularly scheduled time but the employee is
paid at the regular hourly rate, the extra pay is called overtime pay. If an
additional rate is allowed for the extra hours worked, the additional rate earned is
referred to as overtime premium. The premium pay rate is added to the
employee’s regular rate for the additional hours worked. The premium rate will
depend on the collective bargaining agreement (CBA) between management and
the union.
To illustrate how a payroll is calculated where overtime premium is a factor,

assume an employee regularly earns P 30 per hour for an 8-hour day. If called
upon to work more than 8 hours in a working day, the company will have to pay
overtime premium for hours worked in excess of 8 hours. Assuming the
employee works 12 hours on Monday, is paid 50% overtime premium (time-and-
half) the eamings would be calculated as follows:

Direct labor - 8 hours at P 30 P 240

Factory overhead (overtime premium - 4 x 15) 60 _ 180
Total earnings P_420
If the above employee is paid a premium of 100% (double-time), the earnings

would be:

Factory overhead (overtime premium-4 x 30) 120 240
P_480
With the preceding illustration, the regular rate (240 + 120) will be charged to
Work in Process, while the overtime premium (60 in the first illustration and 120
in the second illustration) will be charged to Factory Overhead Control. By
charging the overtime premium to the factory overhead account, all jobs worked
on during the period share the cost of overtime premiums paid. If the job
contract stipulated that it was a rush contract, it would be appropriate to charge
the premium pay to the job (Work in Process) instead of to a factory overhead
account.
8.5 EMPLOYER’S PAYROLL TAXES
Payroll taxes imposed on employers include social security premiums, Pag-ibig

fund contributions and medicare premiums. Employers are responsible for
periodically reporting and paying the taxes to the appropriate government
agencies. Employers who fail to file require reports or pay taxes due are subject
to civil, and in some cases, criminal penalties.
SSS Contribution
The Social Security System requires employers to pay social security taxes on
wages and salaries equivalent to approximately 55% of the total contribution
credited to the employee. Let us consider the SSS contribution of an employee
with a salary of P10, 000/month. Per the table - Appendix - the total contribution
is P925 - P506.70 being contributed by the employer and P333.30 deducted from
the employee's salary.
Medicare contributions
The amount contributed by the employer is equal to the amount deducted from
the employee’s salary or wage. The maximum deduction per table P37.50 for
salaries P9,759 and over. The contribution of the employer, maximum, is also
P37.50.

Pag-ibig Funds Contribution
The amount deducted from the employee’s salary is equivalent to 2% of basic or

P100, whichever is lower. The contribution of the employer is also equal to the
amount deducted from the employee.
Illustrative Problem
The Ingrid Manufacturing Company pays employees every two weeks. Monday, May 1,
is the beginning ofa new payroll period.
The following payroll summary is prepared by the payroll department and forwarded to
accounting for recording:
Payroll Summary
for the period May 1-14
Factory Sales and
Employees Adm. Employees Total
Gross Eamings P_100,000 P.30,000 P130,000
Withholdings & deductions:
Income tax P 12,000 P 2,400 P 14,400
SSS Premiums 3,330 950 4,280
Medicare contributions 375 150 525
Pag-ibig contributions 2,000 600 2,600
Total P_ 17,705 P_4,100 P_ 21,805
Net earnings P_ 82,295 P 25,900 P 108,195
After the data are verified, a payroll voucher is authorized and recorded as follows:
May 14 Payroll P 130,000

Withholding Tax payable P 14,400
SSS Premium Payable 4,280
Medicare Contributions Payable 525
Pag-ibig Funds Contributions Payable 2,600
Vouchers Payable 108,195
To record the payment of the net earnings to employees, the
following entry is required:
May 14Vouchers Payable P 108,195

Cash P 108,195

Assuming that of the total factory payroll of P100,000 - P30,000 is indirect labor,
the entry to record the distribution of the payroll is:
Work in Process P 70,000

Factory 30,000
Selling & Adm. Expense Control 30,000
Payroll P 130,000
The following schedule provides the information necessary to record the

employer's payroll taxes for the period.
SSS Premiums Medicare Pag-ibig Total

Factory payroll 5,067 375 2,000 7,442
Selling & Adm. 3,540 150 600 4.290
Total 8,607 525 2,600 11,732
The entry to record the employer’s payroll taxes is as follows:
Factory Overhead Control P 7,442

Selling & Adm. Expense Control 4,290
SSS Premiums Payable P 8,607
Medicare Contributions payable 525
Pag-ibig Funds Contributions Payable 2,600
8.6 CLASSIFICATION FOR LABOR

1. Direct labor - labor identified with particular products which are
considered feasible to be measured and charged to specific production
order cost sheet.
2. Indirect labor
a. Labor identified with particular products but which is not
considered feasible to measure and charge to a specific production
order.
b. Labor expected for the benefit of production in general and not
identified with particular products.
Labor losses - labor allowances and make-up payments made on time
we
spent with no production or with substandard production.

a. Waiting time or idle time - cost of non-productive hours of direct
labor caused by lack of work, waiting for materials or mass
assignment to a job, and delays from scheduling and machine
breakdown. Idle time maybe charged only for what is considered
normal, abnormal items should be charged to losses.

b. Machine set-up time - cost of non-productive hours of direct

labor paid to workers while machines are being prepared for new
jobs.
Cc. Transfer allowance - difference between earnings regularly
earned on piecework and earned by the worker if he is
transferred from one department to another.
a. Make-up pay - difference between earnings on piece work and
earnings at guaranteed hourly and weekly rates.
b. Labor re-operation - cost of additional labor necessary to correct
defects in production which fails to pass inspection.
Labor Overhead
a. Overtime premium - extra pay for work after normal closing time
for holidays and Sundays.
b. Shift premium - extra pay to work during less desirable evening
shift.
Cc. SSS Contributions - amounts remitted to Social Security System
in form of premiums, medicare and workmen’s compensation.
d. Holiday and vacation pay - payments for non-productive labor
while employees are absent on authorized holidays and
vacation.
8.7 GROSS EARNINGS OF EMPLOYEES

1. Wages - gross earnings of an employee who is paid by the hour for only
the actual hours worked.
2. Salaries - gross earnings of an employee who is paid a flat amount per
week or month regardless of the hours worked in a period.
2
». Gross earnings - the compensation of an employee and includes regular
pay and overtime premiums.
8.8 PAYROLL DEDUCTIONS

1, Employee’s income tax - the amount of tax to be withheld each period
depends on the following:
a. Amount of the employee’s earnings.
b. Frequency of the payroll period, and
Cc. Classification of the taxpayer and number of qualified
dependents.
Social Security System premiums - levied against both the employer and
the employee (based on table provided).
Medicare Contributions - levied against both the employer and the
ww
employee (in equal amounts provided).

(This page is intentionally left blank.)

EXERCISES
1. Table and Chair Manufacturing Company received orders from customers on

January 1, 2008, as follows:
Job No. 101 Blims Company placed an order for 50 tables. The price
agreed upon for the job is P 25,000. January 18 is the
expected date of completion
Job No. 102 Nice Furniture Store placed an order for 24 chairs. The price
agreed upon for the job is P 4,000. January 25 is the
expected date of completion.
Both jobs will be formed in the Assembly Department ad cleaned and checked in
the Finishing Department. The Table and Chair Manufacturing Company uses a
job order system. The following information relates to jobs 101 ad 102.
1. The Purchasing Department purchased the following on January 2, 2008.

Direct materials
100 sheets of narra for P1 4,000
Indirect materials
20 cases of glue for P500
10 cases of nails for P300
50 gallons of varnish for P 200
2. The following materials were requisitioned

Quantity Description Amount
Assembly Department
Job 101 75 sheets Narra P 10,500
Job 102 7 sheets Narra 980
Finishing Department
10 gallons Varnish 40
3. Labor costs according to labor time cards and payroll summary were as
follows
Assembly Finishing Total
Direct labor -Job 101 P 2,750 P 425 P3, 175
- Job 102 1,200 270 1,470
Indirect labor 700 100 800
4. Additional factory overhead incurred
Rent Expense P1, 500
Depreciation - machines 360
Depreciation - factory building 490
Utilities expense 225
Payroll taxes 300

5. Factor overhead is applied to each job upon completion as follows:

Assembly Department - 120% of direct labor cost
Finishing Department - 75% of direct labor cost
6. Job 101 was completed on January 16 and Job 102 was completed on
January 23
Both jobs were transferred to the finished goods storeroom upon completion.
7. Both jobs were picked up by the customers who paid cash.
Required:
1. Journal entries for the above transactions
2. Job order cost sheets for Job 101 and 102
An invoice for X, Y, and Z is received from Heavyweight Co. Invoice totals are: X
-P 11,250; Y - P 13,500; Z - P15, 750. The freight charges on this shipment of
18,000 pounds total P1, 620. Weights for the respective materials are 4,500,
6,000, and 7,500 pounds.
Required:
1. Cost per pound to be entered on the stock cards for each materials, based
on cost.
2. Cost per pound to be entered on the stock cards for each material, based on
shipping weight.
The Heaven & Earth Company made the following material purchases and
issues during January:
January 1 Balance on hand, 1,000 units at P4.00 each
3 Issued 250 units
5 Received 500 units at P4.50 each
6 Issued 150 units
10 Issued 110 units
11 Factory returned 10 units to the store room that were
issued on the 10”
15 Received 500 units at P5.00 each
20 Returned 300 units to vendor from May 15" purchase
26 Issued 100 units
Required: Cost of materials used and inventory, end using:

1. First-in, first-out
2. Average.

4. The Bedrock Company is a manufacturer of golf clothing. During the month, the
company cut and assembled 8,000 golf jackets. One hundred of the jackets did
not meet specifications and were considered “seconds.” Seconds are sold for
P80.00 per jacket, whereas first quality jackets sell for P399.50. During the
month, Work in Process was charged for a total of P1, 320,000: P360, 000 for
materials, P480,000 for labor, and P480,000 for factory overhead.
Required: Entries required for each of the following conditions:

a. Loss due to spoiled work is spread over all jobs.
b. Loss due to spoiled work is charged to this specific job.
5. Colossal Corporation estimates factory overhead of P207, 000 for the next fiscal
year. It is estimated that 52,100 units will be produced at a material cost of
P500,000. Conversion will require an estimated 85,000 direct labor hours at a
cost of P9.00 per hour, with 69,000 machine hours.
Required: Calculate the predetermined factory overhead rate based on:

1. Material cost
2. Units of production
3. Machine hours
4. Direct labor hours
5. Direct labor cost
6. The Dovin Company is studying the results of applying factory overhead to

production. The following data have been used: estimated factory overhead,
P60,000; estimated materials costs, P50,000; estimated labor costs, P60,000;
estimated direct labor hours, 40,000; estimated machine hours, 25,000; work in
process at the beginning of the month, none.
The actual factory overhead incurred for the month of November was P55,000,
and the production statistics at November 30 are:
Materials Direct Labor Direct Labor Machine Date Jobs

Job Cost Cost Hours Hours Completed
101 P 5,000 P 7,200 5,000 3,000 Nov. 10
102 7,000 10,000 6,000 3,200 Nov. 14
103 8,000 11,000 6,500 4,000 Nov. 20
104 9,000 9,000 5,600 3,400 In process
105 10,000 15,000 10,000 6,500 Nov. 26
106 11,000 4,200 3,000 1,500 In process

Required:
1. Calculate the predetermined rate based on:
a. Direct labor cost
b. Direct labor hours
c. Machine hours
2. Using each of the methods, compute the total cost of each job at the end of
the month.
7. Thermal Corporation has two producing department and two service departments
labeled P1, P2, S1, and S2, respectively. Direct costs for each department and
the proportion of services costs used by various departments are as follows:
Cost Direct Proportion of services used
by:
Center Costs si $2 Pi
P2
P1 P90,000
P2 60,000
$1 20,000 - 80 10
10
$2 32,000 .20 - 50
30
In calculating predetermined overhead rates, machine hours are used as the
base in P1 and direct labor hours as the base in P2.
Pi P2
Machine hours 50,000 40,000
Direct labor hours 40,000 20,000
Requirements:
1. Allocate the service department costs to operating departments and compute
the factory overhead rate for P1 and P2 using the following methods:
a. Direct Method
b. Step method - start with $1
c. Algebraic method
2. Assume the company uses just one basis for applying overhead to jobs
going through both P1 and P2, compute the overhead rate using direct labor
hours as base.

8. A weekly payroll summary made from time tickets shows the following data:
Number of Hours
Employee Classification Rate/Hour Regular Overtime
Austria, B. Direct P36 40 2
Bautista, D. Direct 36 40 3
De Santos, M. Direct 45 40 4
Motus, R. Indirect 30 40
Reyes, A. Indirect 30 40
Overtime is payable at one-and-a-half times the regular rate of pay for an

employee.
Required:
a) Determine the net pay for each employee.
b) Prepare journal entries for:
1. Recording the payroll.
2. Payment of the payroll.
3. Distribution of the payroll.
4. The employer's payroll taxes.
9. The Norman Company recently adopted an incentive plan. Factor workers are
paid P7.50 per unit with a guaranteed minimum wages of P2, 000 per week.
Following is a report on employees’ productivity for the week ending May 19,
2011. All employees worked the full 40-hour week.
WEEKLY SUMMARY
EMPLOYEE’S NAME UNITS PRODUCED
R. Cruz 240
J. Briones 286
C. David 275
A. Mendoze 240
F. Rivera 225
R. Tolentino 285
Required:
1. Compute each employee’s gross pay?
2. 2.\What amount should be charged to work in process?
3. What amount should be charged to factory overhead control?
10. A rush order was accepted by the Ty-Nee Trailer Company for five trailers. The
time tickets and clock cards for the week ended March 27 show the following:

Time Tickets - Hour distribution

Trailer Trailer Trailer Trailer Trailer Trailer
Employees Hours #1 #2 #3 #4 #5
Castro Ss 42 all time spent supervising
Ardina ME3 45 10 10 10 10 5
Briones HF 48 24 24
David Ss 48 24 24
Fajardo ME 45 15 15 15
Tomas ME1 42 24 8
Villas ME 40 20 10
All employees are paid P40 per hour, except Ardina, who receives P50 per hour.
All overtime premium pay except Ardina’s is chargeable to the job and all
employees, including Ardina, received time and a half for overtime hours.
Required
1. Calculate the total payroll and total net earnings for the week. Hours not
worked on trailers are charged to factory overhead.
2. Prepare entries to record, pay, and distribute the payroll.

2 - Accounting for Materials, Labor, And Overhead

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MODULE 2

Accounting for Materials, Labor and Overhead Costs

This module covers the following learning

1. Describe the methods and procedure of

1.0 ACCOUNTING FOR MATERIALS

2.0 MATERIALS CONTROL

3.0 Physical Control of Materials

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3.3 Segregation of Duties. The following functions should be segregated to

3.4 Accuracy in Recording. Inventory records should permit the determination of

4.0 Controlling the Investment in Materials.

100 units (daily usage) x 4 days (lead time) 400 units

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1. Salaries and wages of employees engaged in purchasing, receiving, and

4.4 Factors to be considered in determining carrying costs typically include:

4.5 METHODS OF COMPUTING ECONOMIC ORDER QUANTITY

4.5.1. TABULAR METHOD —- Under this method, several purchase order

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4.5.3 FORMULA METHOD -— The formula method is easy to use and it

EQQ = /2xAD x CPO

4.5.4 ILLUSTRATIVE PROBLEM 1

Using the EOQ formula:

EOQ = 2 (annual demand) (cost per order)

4.5.5 ILLUSTRATIVE PROBLEM 2

Desired annual return on inventory investment (10% x 400) P 40

Costs per purchase order — clerical costs, supplies,

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SOLUTION TO ILLUSTRATIVE PROBLEM 2

1. EOQ 2 (annual demand) (cost per order)

2. a) Annual ordering cost = 5,000 x50 = P2,500

b) Annual carrying cost = 100 x 50 = P 2500

4.4 Order Point

4.4.2 ILLUSTRAIVE PROBLEM 2

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4.5 Safety Stock

4.5.2 ILLUSTRATIVE PROBLEM 3

100 units (daily usage) x 4 days (lead time) 400 units

5.0 BUSINESS PAPERS USED TO SUPPORT MATERIAL

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FIGURE 2.1 PURCHASE REQUISTION

NORTHERN CONSOLIDATED COMPANY

Department or individual making the request Forming Department

ORDER DATE 1/1/08 DELIVERY DATE REQUESTED 1/03/08

QUANTITY DESCRIPTION UNIT PRICE TOTAL

TOTAL COST P3,300

Using the Illustrative problem of Chapter 4, the Forming Department

5.2 PURCHASE ORDER - is a written request to a supplier for specified goods at an

If the purchase requisition is properly completed, the purchasing department will

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FIGURE 2.2 PURCHASE ORDER

NORTHERN CONSOLIDATED COMPANY

SUPPLIER: Ellery Company Cubao, Q. C ORDER DATE ~— 1/02/08

DELIVERY TERMS _ FOB Terms PAYMENT TERMS n/30

QUANTITY DESCRIPTION UNIT PRICE TOTAL

TOTAL COST P3,300

FIGURE 2.3 RECEIVING REPORT

PURCHASE ORDER NO. 015

QUANTITY DESCRIPTION DISCREPANCIES