Accounting for Materials
Instructor: Edsa A. Lanuza, MBA
Materials
• Means any commodity or substance which is processed in a factory in order to be converted into
finished product.
• First and most important element of cost.
Direct Materials – materials which form a part of a finished product.
Indirect Materials – materials which cannot be conveniently and accurately allocated to a particular unit
of product.
• Considerations in choosing materials:
1. Type of materials needed
2. Quality of materials
3. Quantity needed
4. Price (cost) per unit
2 Systems of Inventory Recording
• Periodic Inventory System
Facilitates the physical counting of materials at the end of
accounting or production period, whereby the updated balances of
materials is based on this physical count.
• Perpetual Inventory System
Facilitates recording of movement of materials in every purchase
and issuance to production through the use of stock cards. Inventory
records are updated in every internal manufacturing transaction.
Control Procedures
• It is of utmost importance that a company has a good system of materials inventory.
• Achievement of good control keeps costs at a minimum level and plant production on a smooth,
uninterrupted schedule.
Commonly Used Control Procedures
• Order Cycling – method where materials on hand are reviewed on a regular or periodic cycle, like let’s
say every 30 days.
• Min-max method – based on the assumption that materials inventory have minimum and maximum
levels.
• Two-bin method – used for materials that are considered inexpensive and/or nonessential.
• Automatic order system – used by most companies that are computerized.
• ABC Plan – method used by companies with a large number of materials, each one having a different
value.
Economic Order Quantity (EOQ)
• According to Investopedia, EOQ is the ideal order quantity a company should purchase to
minimize inventory costs such as holding costs and order costs. The model assumes that
demand, ordering, and holding costs all remain constant.
• Formula:
EOQ = 2CN
K
where:
2 = constant
C = cost of placing an order
N = number of units required annually
K = carrying cost per unit of inventory
Order Point
• The point at which an item should be ordered. Once the EOQ has been determined,
management must decide when to place the order.
1. Usage – the anticipated rate at which the materials will be used.
2. Lead time – the estimated time interval between the placement of the order and the
receipt of the materials ordered.
3. Safety stock – the estimated minimum level of inventory needed to protect against
running out of stock.
Formula:
Order point = usage x lead time
Revised order point = (usage x lead time ) + safety stock
Business Papers used to support material transactions:
1. Purchase Requisition – is a written request, usually sent to inform the purchasing department
of a need for materials or supplies.
2. Purchase Order – is a written request to a supplier for specified goods at an agreed upon price.
3. Receiving Report – When the goods that were ordered are delivered, the receiving department
will unpack and count them.
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.
Methods of Costing Materials
• First-in, First-out (FIFO) Method
Assumes that the first stock to be received is first to be sold.
The cost of materials used is based on the oldest prices.
• Moving average Method
is calculated after each new purchase, and this amount is used to cost
each subsequent issuance until another purchase is made.
• Discounts - constitute a reduction in the list price.
1. Trade discounts – generally given in terms of percentage (15% , 10%, 5%) and are not
recorded on the books because purchases are recorded on the books net of the discount.
2. Quantity discounts – represent cost savings for volume purchases.
3. Cash discounts – granted to customers to motivate them to pay promptly.
• Freight-In
1. 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 (perpetual inventory system)
or debited as freight-in (periodic).
2. Indirect charging – the freight incurred on the purchase of raw materials is charged to
Factory Overhead Control account.
Spoiled Units, Defective Units, Scrap Materials and
Waste Materials in a Job Order Cost System
• Spoiled Units – are units that do not meet production standards and are either sold for their
salvage value or discarded. When spoiled units are discovered, they are taken out of
production and no further work is performed on them.
• Defective Units – are units that do not meet production standards and must be processed
further in order to be saleable as goods units or as irregulars.
• Scrap materials – are left over from the production process that cannot be put back into
production for the same purpose, but may be usable for a different purpose or production
process or which may be sold to outsiders for a nominal amount.
• Waste materials – are left over from the production process that has no further use or resale
value and may require cost for their disposal.
