CHAPTER 2
Accounting for Raw Materials
SEPTEMBER 07, 2021
Learning Outcomes:
After this chapter, the student will be able to:
Differentiate perpetual inventory and periodic inventory system of handling
inventories
Journalize transactions related to raw materials: purchases, returns to suppliers
and freight under perpetual and periodic inventory system
Differentiate FIFO and average method of inventory valuation
Understand and apply Economic Order Quantity (EOQ) as a method of managing
raw materials inventories.
Journalize transactions under Just in Time (JIT) using back flush accounting
Account for scrap materials
Compute the cost of raw materials used using standard costing system
BASIC TRANSACTIONS ASSOCIATED WITH RAW MATERIALS(Perpetual Inventory
System)
1. Purchase of Raw Materials - The cost of raw materials is debited to Raw Materials
Inventory when the materials are received. This account is debited for the invoice cost
and freight costs chargeable to the purchaser. It is credited for purchase discounts
taken and purchase returns and allowances.
2. Freight in or Transportation costs. - Freight in or transportation costs of raw
materials purchased is a production costs. Under the perpetual inventory system, the
freight is charged to Raw Materials account.
3. Inventory Stock Card - The stock card is used to record movement of the inventory.
4. Issuance of Raw Materials - A material requisition form completed by the production
supervisor is the basis of the raw material inventory clerk for the release of the
materials.
5. Materials Requisition Form - The requisition indicates the quantity, material number,
description, and job number to which the materials are to be charged.
6. Scrap Materials - Scrap materials are defective materials or leftover materials in
production.
INVENTORY VALUATION METHODS
The most common methods of valuing raw materials are:
a) FIFO (First-in, first out) - Under FIFO Method, raw materials inventory is reported at latest cost while the
Cost of Raw materials used is reported at earliest cost. In a period of rising prices, this method will yield a
higher gross profit because the cost of goods sold is assigned lower cost.
b) Average Cost
a. Weighted average - This method is based on the assumption that units issued should be charge 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.
b. Moving average - 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.
Illustrative Problem
Determine the ending inventory under
a. FIFO
b. Weighted Average
c. Moving Average
FIFO METHOD
Date Received Issued Balance
01-Aug 400 @ P10 4,000.00
12-Aug 600 @P12 7,200.00 400 @ P10 4,000.00
600 @ P12 7,200.00
16-Aug 400 @ P10 4,000.00
100 @ P12 1,200.00 500 @ P12 6,000.00
18-Aug 300 @ P15 4,500.00 500 @ P12 6,000.00
300 @ P15 4,500.00
20-Aug 200 @ P12 2,400.00 300 @ P12 3,600.00
300 @ P15 4,500.00
25-Aug 400 @ P14 5,600.00 300 @ P12 3,600.00
300 @ P15 4,500.00
400 @ P14 5,600.00
28-Aug 300 @ P12 3,600.00 200 @ 15 3,000.00
100 @ P15 1,500.00 400 @ P14 5,600.00
WEIGHTED AVERAGE
Weighted Average
Number of Units Cost per Unit
Total Cost
400 units 10.00 4,000.00
600 units 12.00 7,200.00
300 units 15.00 4,500.00
400 units 14.00 5,600.00
1700 21,300.00
Weighted averge unit cost = 21300
1700
= 12.53
Inventory, end 600 units x P12.53 7,518.00
MOVING AVERAGE
Date Received Issued Balance
01-Aug 400 @ P10 4,000.00
12-Aug 600 @P12 7,200.00 1000 @ P11.20 11,200.00
16-Aug 500 @ P11.20 5,600.00 500 @ P11.20 5,600.00
18-Aug 300 @ P15 4,500.00 800 @ P12.625 10,100.00
20-Aug 200 @ P12.625 2,525.00 600 @ P12.625 7,575.00
25-Aug 400 @ P14 5,600.00 1000 @ P13.175 13,175.00
28-Aug 400 @ P13.175 5,270.00 600 @ P13.175 7,905.00
Jupiter Company had 150 units of product on hand at January 1 costing P21 each. Purchases of Product A during the
month of January were as follows:
Units Unit Cost
10-Jan 200 ₱ 22.00
18-Jan 250 23.00
28-Jan 100 24.00
Physical count on January 31 shows 250 units of Product A on hand.
The cost of the inventory at January 31, under the FIFO method is:
The cost of the inventory at January 31, under the weighted average method is:
Under FIFO= P5,850
Under weighted average = P5,705
ECONOMIC ORDER QUANTITY (EOQ)
- The Traditional Inventory Model
- is designed to help the production manager determines the amount of stock to
be purchased every time an order is made or to produce with each production
run to minimize total inventory costs.
- the order size for an inventory item that results in the lowest total inventory
costs for a period.
ECONOMIC ORDER QUANTITY (EOQ)
Let assume the following:
Number of units of materials required annually 10,000
Cost of placing an order P10
Annual carrying cost per unit of inventory P0.80
EOQ
EOQ = 500 UNITS
Carrying Costs- which includes costs of storage, insurance, inventory taxes, spoilage and pilferage, opportunity cost of
Funds tied up with inventory and handling costs
Ordering cost- which include costs of placing and receiving orders like cost of processing documents, insurance for
Shipments and unloading costs.
EOQ = 500 units
No. of Orders = Annual demand/ EOQ
= 10,000 / 500
= 20 orders
Time to order = 360 days/ 20 = 18 days
This mean that the company should make an order of 500 units every 18 days.
The cost of ordering = No. of orders per year x cost per order
= 20 x P10
= P200
The cost of carrying the inventory
= Average inventory x carrying cost per unit
= 500/2 x 0.80
= P200
Total Inventory costs = Carrying costs + ordering Costs
= P200 + P200
= P400
