COST ACCOUNTING NOTES.
1. Material Cost Accounting
Material cost is the total cost of acquiring raw materials and is classified
into:
• Direct Materials: Used directly in production (e.g., wood for
furniture).
• Indirect Materials: Used in production but not directly traceable
to a unit (e.g., glue, lubricants).
Example Calculation of Material Cost
A company produces 1,000 tables in a month. The costs incurred are:
• Wood: $20,000
• Glue and nails (indirect materials): $1,500
• Labor & overhead costs: $5,000
Total Material Cost = Direct Materials + Indirect Materials
= $20,000 + $1,500
= $21,500
Material Cost Per Table = Total Material Cost / Total Units
= $21,500 / 1,000
= $21.50 per table
2. Material Issues & Receipts (Inventory Management)
When materials are received (purchased):
• Inventory increases
• Cash or accounts payable increases
When materials are issued to production:
• Inventory decreases
• Work-in-progress (WIP) account increases
Journal Entries for Material Transactions
Purchase of Raw Materials
Company buys 500 units of steel at $10 per unit, total cost $5,000, on
credit.
Journal Entry:
nginx
CopyEdit
Raw Material Inventory $5,000
Accounts Payable $5,000
Issuing Materials to Production
200 units of steel issued to production.
Journal Entry:
nginx
CopyEdit
Work in Progress (WIP) $2,000
Raw Material Inventory $2,000
3. Inventory Control Methods
Inventory control ensures optimal stock levels, preventing overstocking
or stock shortages.
(i) FIFO (First-In, First-Out)
• Oldest inventory is used first.
• Useful for perishable goods.
Example:
Date Purchase Unit Cost Quantity Total Cost
Jan 1 Purchase $5 100 $500
Jan 5 Purchase $6 100 $600
Now, if 120 units are issued:
• 100 units @ $5 = $500
• 20 units @ $6 = $120
• Total Issued Cost = $620
(ii) LIFO (Last-In, First-Out)
• Newest inventory is used first.
• Common for industries with rising prices.
Using the same purchase data:
• 100 units @ $6 = $600
• 20 units @ $5 = $100
• Total Issued Cost = $700
4. Ledger Posting for Inventory
Material transactions are recorded in the inventory ledger to track
material flow.
Example Ledger Entries
Date Details Debit ($) Credit ($) Balance ($)
Jan 1 Purchase of Materials 5,000 - 5,000
Date Details Debit ($) Credit ($) Balance ($)
Jan 5 Purchase of Materials 3,000 - 8,000
Jan 10 Issued to Production - 4,500 3,500
Jan 15 Additional Purchase 2,000 - 5,500
5. Important Inventory Formulas
1. Material Cost Per Unit
Material Cost Per Unit=Total Material CostTotal Units Produced\text{M
aterial Cost Per Unit} = \frac{\text{Total Material Cost}}{\text{Total
Units
Produced}}Material Cost Per Unit=Total Units ProducedTotal Material
Cost
Example Calculation:
Total Material Cost = $15,000
Total Units Produced = 3,000
Material Cost per Unit = $15,000 ÷ 3,000 = $5 per unit
2. Inventory Turnover Ratio
Inventory Turnover=Cost of Goods Sold (COGS)Average Inventory\text
{Inventory Turnover} = \frac{\text{Cost of Goods Sold
(COGS)}}{\text{Average
Inventory}}Inventory Turnover=Average InventoryCost of Goods Sold (
COGS)
Example Calculation:
COGS = $50,000
Average Inventory = $10,000
Inventory Turnover = $50,000 ÷ $10,000 = 5 times
(Meaning inventory is sold and replaced 5 times in a period)
3. Reorder Level
Reorder Level=Maximum Usage×Lead Time\text{Reorder Level} =
\text{Maximum Usage} × \text{Lead
Time}Reorder Level=Maximum Usage×Lead Time
Example Calculation:
Maximum daily usage = 50 units
Lead time = 4 days
Reorder Level = 50 × 4 = 200 units
