ACCOUNTING FOR MATERIALS

Cost Accounting
2

Gathering of cost information Attachment of costs to cost objects Establishment of budgets, standard costs, actual costs (of operations, processes, activities or
products)

Analysis of variances, profitability or the social use of funds

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Cost Object
3

Anything for which a separate measurement of cost is desired (Examples: product, service or department)

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Scope of Cost Accounting

4

The foundation of the internal financial information system to facilitate: CONTROL (organization and constituent parts work
efficiently towards agreed objectives)

DECISION-MAKING (choice between alternatives) PLANNING (what cost will be like in the future, provide
standards targets against which to compare actual results)

ESTIMATING & PRICING

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Unit Objectives
5

1.

Describe the different procedures and documents necessary for ordering, receiving and issuing materials from inventory Describe the control procedures used to monitor physical and book inventory to minimize discrepancies and losses.

2.

3.

Interpret the entries and balances in the material inventory account

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Unit Objectives
6

4.

Prepare calculations, with explanations, of the costs of ordering and holding inventory (including buffer inventory) Calculate optimal reorder quantities including situations where discounts apply. Interpret optimal reorder quantities including situations where discounts apply.
Lorence Brown, UTECH

5.

6.

Unit Objectives
7

7.

Produce calculations to minimize inventory costs when inventory costs when inventory is gradually replenished. Apply appropriate methods for establishing reorder levels where demand in the lead time is constant Calculate the value of closing inventory and material issues using LIFO, FIFO and average methods
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8.

9.

Inventory Control System

8

Controls should cover the following functions:

1.

The ordering of inventory The purchase of inventory

2.

3.

The receipt of goods into stores

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Inventory Functions Requiring Control

4.

The storage of goods The issue of inventory. Maintenance of inventory at most appropriate level

5.

6.

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Reasons for Controlling Inventory

10

1.

Holding costs may be expensive Production will be disrupted if we run out of raw materials Unused inventory with short shelf life may incur unnecessary expenses

2.

3.

4.

Ensure quality inputs used to maintain good reputation with customers

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Ordering & Receiving Materials

11

Every movement of material should be documented using the following: 1. Purchase requisition
2.

Purchase order
Goods received note (GRN) Materials requisition, transfer or returned note.
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3.

4.

Ordering, receipt and issue

12

Proper records of physical procedures for ordering and receiving ensure:

Enough inventory is held No duplication of ordering Quality is maintained Adequate record for accounting purposes
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Ordering & Receiving Materials Documents used (1)

13

Purchase Requisition

From stores to purchasing department

Request for Quotations

From purchasing to potential suppliers to secure the best mix of quality and prices

Purchase Order

From purchasing to supplier, accounts payable, originating dept, stores/goods receiving dept.
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Ordering & Receiving Materials Documents used (2)

14

Delivery note sent by supplier with goods which are then checked against the purchase order for quality and quantity Goods Received Note
From stores to accounts payable

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Goods Receival
15

Incoming goods taken to central goods receiving department facilitates control Ensure goods arriving actually agree in detail to those ordered (purchase order, delivery note, counted, inspected)

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Goods Receival
16

GRN prepared as evidence that goods ordered received and can be paid for) Copies sent to accounts for comparison with suppliers invoice and payment to be made. Basis for entering receipts of materials in stores (warehouse) records
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Issuing Materials - Documents used

17

1.

Materials requisition note

records the quantity of goods issued to different departments (or production jobs)

2.

Materials transfers and returns

transfer note prepared where goods are transferred to another dept or job

3.

Materials returns
returned note prepared where goods not used are returned to the stores dept.
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Form Purchase Requisition

18

PURCHASE REQUISITION Date __________________ Serial No._____________ Purpose: _____________________ (inventory/special capital equipment/budget ref) Qty Descri Mater ption -ial Code Job/ Dept Code Delivery Reqd Date Place Purchase Order No. Date Suppl -ier

Origination Dept. _________________ Authorization ____________

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Form Purchase Order

19

PURCHASE ORDER To________________ Serial No:______________ Date____________ Purchase Req. No._______ Qty Descriptio Code n Delivery Date Price Per (unit)

Your quotation_______________ To be delivered carriage paid to _____________________

Please quote our Purchase Order number on all correspondence.

For ABC Ltd. ____________________________________
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Form - Goods Received Note

20

GOODS RECEIVED NOTE To_____________________ Serial No. ________________ Date Issued: _______________Carrier_________________ Date of delivery___________ Purchase Order No. _________
Description

Code

Quantity

Packages Gross Weight Recd by ____________ Reqd by ____________

INSPECTION REPORT
Qty passed Qty rejected

Remarks

Accepted:___________ Inspector______________ Date __________ Date: _______________

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21

Computerized Inventory Control Systems (1)

Many systems are computerized and most have the following features:

Data must be input into the system may be from the various forms or the information is keyed directly into the system and hardcopies can be printed

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22

Computerized Inventory Control Systems (2)

An inventory master file is maintained i.e. database with details for every category of inventory

The system will generate outputs hardcopy records, VDU screen display or printed reports.

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Objectives of Storing Materials 1

23

1.

Speedy issue and receipt of materials Full identification of all materials at all times

2.

3.

Correct location of all materials at all times

Protection of materials from damage and deterioration

4.

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Objectives of Storing Materials 2

24

5.

Provision of secure stores to avoid pilferage, theft and fire Efficient use of storage space Maintenance of correct inventory levels

6.

7.

8.

Keeping correct and up-to-date records of receipts, issues and inventory levels
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Recording Inventory Levels

25

Most frequently encountered system for recording inventory movements are Bin Card

Kept with the actual inventory and updated with receipts and issues

Stores Ledger Account

Shows receipts, issues, $ values, inventory control levels and running balances.
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Bin Card
26

Part No._________________ Bin No. ________________ Receipts Date Qty GRN

Location: ___________________________ Stores Ledger No. ____________________ Issues Balance Req No.

Date

Qty

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Stores Ledger Account

27

Material ____________________ Maximum Qty ________________________ Code ______________________ Minimum Qty ________________________ Date GRN Receipts Qty Unit Price $ Amt $
Stores

Issues Req. No. Qt y Unit Price $ Amt $ Qty

Inventory Unit Price $ Amt $

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Free Inventory Free Stock Balance (FSB)

28

Scenario: You are the storekeeper. On Monday of this week, the production manager requests 100 pieces of foam. She needs them on Friday but you only have 50 pieces. Give me reasons why you may not be troubled by the insufficient quantity of foam pieces on hand.
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Free Inventory Free Stock Balance (FSB)

29

Physical stock

Useful for issuing, stocktaking, controlling stock levels

Free Stock

Useful for replenishment ordering

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30

Free Inventory Free Stock Balance (FSB)

FSB provides a full picture of the current inventory position what is really available for future use.

FSB = Materials on hand + Materials on order from suppliers Materials requisitioned, not yet issued.

Lorence Brown, UTECH

Question on FSB
31

A wholesaler has 8,450 units outstanding for part X100 on existing customers orders; there are 3,925 units in inventory and the calculated free inventory is 5,525 units.

How many units does the wholesaler have on order with his supplier?
A: 9,450 B 10,050 C 13,975 D 17,900

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Identification of Materials (1) (inventory/materials codes)

32

Materials held in stores are coded and classified and provide the following advantages
1.

Ambiguity is avoided Time is saved descriptions can be lengthy and time consuming

2.

Identification of Materials (2) (inventory/materials codes)

33

3.

Production efficiency is improved correct material can be accurately identified from a code number

4.

Computerized processing is made easier

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Identification of Materials (3) (inventory/materials codes)

34

4.

Numbered code systems can be designed to be flexible and can be expanded to include more inventory items as necessary
Digits in a code can stand for type of inventory, supplier, department and so forth.

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The Inventory Count (Stocktake)

35

Involves counting the physical inventory on hand at a certain date, and then checking this against the balance shown in the inventory records.

36

The Inventory Count (Stocktake)

There are 2 approaches:

Periodic: all items (raw materials, WIP and finished goods) counted and valued at a set time, usually accounting year-end
Continuous: counting and valuing selected items at different times on a rotating basis. Involves a specialist team counting and checking a number of items each day.
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Advantages of Continuous Stocktaking (1)

37

1.

Annual stocktake unnecessary and the disruption it causes Skilled stocktakers employed reduces likely errors More time available reduces errors and allows investigation

2.

3.

Advantages of Continuous Stocktaking (2)

38

4.

Deficiencies and losses revealed sooner for corrective action to be taken

Production hold-ups are eliminated as stores staff always available to deal with issues

5.

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Advantages of Continuous Stocktaking (3)

39

6.

Staff morale improved and standards raised

Control over inventory levels is improved less likelihood of overstocking or stockouts

7.

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Reasons for Inventory Discrepancies 1

40

Discrepancies will occur investigate the causes and take corrective action
1.

Quantity errors eg, miscounts during the stock take. Classification errors eg, a stainless steel part classified as mild steel

2.

Reasons for Inventory Discrepancies 2

41

3.

Pricing errors e.g., a correctly counted and classified item might be priced at $56 for 1000 instead of $56 per 100

4.

Recording errors e.g., an omission of the entry of a goods received note.

Systems error e.g., no adequate recording of returns to stores.
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5.

Perpetual Inventory
42

This is an inventory recording system whereby the records (bin cards and stores ledger accounts) are updated for each receipt and issue of inventory as it occurs.

There is a continuous record of the balance on hand which is used to calculate the inventory figure for the financial statements
Continuous stocktaking is necessary to ensure the perpetual system is functioning correctly

Obsolete, deteriorating and slow moving inventories and wastage

43

Obsolete (out-of-date) items should be written off and disposed of if no longer required. Inventory items may be wasted (eg broken, damaged) write-off, update inventory records and accounts. Slow moving (quantity on hand will take a long time to be used up). Excess inventory to be written off as obsolete inventory.

Preparation for Next Class

44

We will be looking at inventory control levels which will cover the following topics:

Inventory costs Minimum, maximum and reorder levels Reorder quantity Economic order quantity (EOQ) Economic order quantity (EBQ)

Read textbook pages 104-113

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45

INVENTORY CONTROL LEVELS

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Elements of Inventory Costs

46

Purchase Holding (or carrying)

Ordering and
Stockout (costs of running out of inventory

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Reasons for Holding Inventories (1)

47

Ensure sufficient goods are available to meet expected demand Provide a buffer between processes Meet any future shortages

Take advantage of any bulk purchasing discounts

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Reasons for Holding Inventories (2)

48

Absorb seasonal fluctuations in usage/demand Allow production processes to flow smoothly

Necessary part of production process (maturing cheese) Deliberate investment policy (expected inflation or shortages)
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Holding Costs (driven by inventory levels)

49

Storage and stores operations Interest charges

Insurance
Risk of obsolescence Deterioration
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Ordering Costs (driven by frequency of orders)

50

Clerical and administration

Transport Production run

(for inventory manufactured internally)

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Stockout Costs (1)

51

Lost contribution from lost sales

Loss of future sales Loss of customer goodwill

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Stockout Costs (2)

52

Cost of production stoppages

Labour frustration over stoppages Extra costs of urgent, small quantity replenishment orders

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Objective of Inventory Control

53

Maintain inventory levels so that sum total of

holding, ordering and stockout costs are minimized.

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Inventory Control Levels

54

There are 3 critical control levels Reorder

Minimum and
Maximum

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Reorder Level
55

Level at which a replenishment order should be placed Reorder Level = maximum usage (rate of consumption) x maximum lead time Lead time is the time between ordering and replenishment
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Minimum Level
56

Warning level that inventories approaching dangerously low level and stockouts are possible
Mininimum level = reorder level (ave usage x ave lead time

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Maximum Level
57

Warning level that inventories are reaching a potentially wasteful level Maximum level = ROL + reorder quantity (ROQ) (min usage x min lead time)

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Question - Maximum Level

58

A large retailer with multiple outlets maintains a central warehouse from which outlets are supplied. The following is available for part # SF525.

Ave. usage = 350 per day Min. usage = 180 per day Max. usage = 420 per day Lead time for replenishment = 11-15 days Reorder qty. = 6,500 units Reorder level = 6,300 units
Lorence Brown, UTECH

Question - Maximum Level (contd)

59

Based on the above, A. What is the maximum level?

A: 5,250 B: 6,500 C: 10,820 D: 12,800

B. What is the approx. no. of SF525 carried as buffer inventory?

A: 200 B: 720 C: 1,680 D: 1,750

Lorence Brown, UTECH

Example
60

The following data relates to a particular stock item: Maximum Usage 130 units per day Minimum Usage 70 units per day Lead Time 20-26 days EOQ 5000 units Calculate:

ROL (Ans = 3,380) Minimum Level (Ans = 1,080) Maximum Level (Ans = 6,980)

Reorder Quantity & Ave. Inventory

61

ROQ is the quantity of inventory ordered when the ROL is reached

Average inventory (assuming inventory is used evenly)

= safety inventory + ROQ

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Economic Order Quantity

62

EOQ = The optimum order size EOQ is that ROQ that minimizes the balance of cost between ordering (Co) and holding (Ch) costs Can be calculated using a table, graph or formula

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EOQ Assumptions
63

Known, constant per unit stockholding cost

(some costs may increase on a step basis, eg hiring of storekeepers)

Known, constant ordering cost Rates of demand known Known constant price per unit (quantity discounts
may be offered)

EOQ Assumptions 2
64

Replenishment made instantaneously (whole batch is delivered at once) partial deliveries and
delays common

Average stock = Q/2 (violated if constant amount not

used per day; distinct possibility seasonal and cyclical factors produce uneven usage)

Assumptions unlikely in practice but a useful starting point in establishing appropriate ROQ

EOQ
65

Let us say 500k units are needed over a given time period:

5 orders of 100k units incur less ordering costs than 10 orders of 50k 5 orders of 100k units incur more holding costs than 10 orders of 50k

As ROQ increases, Ch increases and Co falls As ROQ decreases, Ch falls and Co increases
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EOQ
66

Average inventory = Q/2 (assume no safety stock) No. of orders = D/Q Annual holding cost = Q/2 x Ch
(i.e., ave. inventory x cost to hold 1 unit for a year)

Annual order cost = D/Q x Co

(i.e. No. of orders x cost to place 1 order)
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EOQ Formula
67

EOQ = 2 x Co x D / Ch Co = ordering cost per order D = demand p.a. (hence @12k per month, D = 144k) or during given time period

Ch = holding cost per item p.a. (often expressed as a %age p.a. of the unit cost)
Note: at EOQ, Total Ch = Total Co

Example
68

The following data relates to a particular stock item: Demand 1000 units per month Ordering Cost $350 per order Unit Cost $8 Carrying Cost 15% per annum Calculate (a) The EOQ (Ans = 2,646) (b) Total holding cost (Ans = $1,587.60) (c) Total ordering costs (Ans = $1,587.60) (d) Total cost (Ans = $3,174.90)

Factors Influencing Choice of Order Quantity

69

Shortage of future supplies Future price increases Obsolescence Steps to reduce safety stocks (eg new supplier with promise of quicker and more reliable delivery)

70

Economic Batch Quantity (EBQ) Formula

EOQ = 2 x Co x D / Ch (1 D/R)
R = production rate per time period Q = the amount produced in each batch D = usage per time period Co = the set up cost per batch Ch = holding cost per unit of inventory per period of time

EBQ
71

Ave. Inventory = Q(1 - D/R) / 2

Total Holding Cost

= [Q(1 - D/R) / 2] x Ch

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Impact of Quantity Discount

72

Assumption of known, constant ordering price violated and so alternate approach required Total Cost = (D/Q x Co) + (Q/2 x Ch) + (D x Unit Price)
Table prepared showing total cost at alternate values of Q Value of Q at which total cost is at a minimum is selected as the optimum ROQ

Question
73

A company uses an item of inventory as follows: Purchase price = $96 per unit Annual demand = 4,000 units Ordering cost = $300 Annual holding cost = 10% of purchase price EOQ = 500 units.

Required:

Ascertain whether the company should order the item 1,000 units at a time in order to secure an 8% discount.
Lorence Brown, UTECH

Periodic Review System

74

Constant Cycle system VARIABLE QUANTITIES, FIXED TIME INTERVALS Stock levels for all parts reviewed at fixed intervals Where necessary, replacement order issued Quantity not previously set based on likely demand until next review, present levels, lead times

Reorder Level System

75

Two-Bin System FIXED QUANTITIES, VARIABLE TIME INTERVALS

Pre-determined order level set for each item When stock falls to ROL, replenishment order issued Replenishment order invariably EOQ

Organizations adopting ROL maintain system that

triggers replenishment order when predetermined reorder level reached. (explain 2-bin concept).

76

Other Systems for Stores Control & Reordering

Classification of materials (ABC method)

Expensive and medium cost materials subject to careful stores control Inexpensive materials stored in large quantities

Pareto (80/20) distribution

80% of value is accounted for by only 20% of stores These should be monitored closely
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77

Accounting Entries for Materials Costs

Material Control Account Payables Control (purchases) X Payable Control (returns to suppliers)) X

WIP (return to stores of materials issued to production)

WIP (direct materials issues to production)

Factory Overheads (issues not directly related to production) Closing Inventory (balancing figure)

XX

XX

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78

CENTRALIZED STORAGE Advantages I (bonus slide)

1.

Lower stock on average Less risk of duplication.

2.

3.

Higher quality staff may be usefully employed to specialize in various aspects of storekeeping
Closer control is possible on a central site.
Lorence Brown, UTECH

4.

79

CENTRALIZED STORAGE Advantages 2 (bonus slide)

4.

Possibly more security from pilferage. Some aspects of paperwork may be reduced, eg, purchase requisitions Stocktaking is facilitated. Likelihood that more advanced equipment will be viable, eg, materials handling, visual displays.
Lorence Brown, UTECH

5.

6.

7.

80

CENTRALIZED STORAGE Disadvantages (bonus slide)

1.

Less convenient for outlying branches/departments. Possible loss of local knowledge. Longer delays possible in obtaining materials.

2.

3.

4.

Greater internal/external transport costs in fetching and carrying materials.

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Layout of Stores (bonus slide)

81

Access for deliveries and issues. Well organized pathways large enough for loaders, forklift trucks etc. Logical distribution of stocked items with the most frequently required items adjacent to issue points. Sufficient horizontal and vertical space for pallets, containers and racks. Good security features eg, external walls, ceiling, TV scanners etc. Space for making up bulk orders and issues
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Example (FIFO, LIFO, AVCO)

82

Receipts of goods

1/Sep: 50 units @ $10 each 5/Sep: 50 units @ $12 each 13/Sep: 50 units @ $14 each
12/Sep: 50 units sold @ $20 each

Issue of goods

Using LIFO, determine the value of closing inventory at the end of the period.
Lorence Brown, UTECH

FIFO, LIFO & AVERAGE COST

83

Remember
1.

You cannot issue/sell what you do not have

Transactions must be processed in strict date order After each transaction, you must determine the make-up of your inventory balance

2.

3.

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FIFO, LIFO & AVERAGE COST

(impact of price movements)
84

Inflationary conditions - rising prices

Earlier and lower priced items sold first, therefore CGS is lower and profits higher Conversely, higher priced items make up closing inventory, which lowers CGS and makes profits higher Under LIFO, the opposite occurs
Conditions opposite to those under FIFO Average cost falls between FIFO and LIFO
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Deflationary conditions - falling prices

Comparison of LIFO vs FIFO (inflationary conditions)

85

CGS

Profit

CI

FIFO
LIFO

L
H

H
L

H
L

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Comparison of LIFO vs FIFO (deflationary conditions)

86

CGS

Profit

CI

FIFO
LIFO

H
L

L
H

L
h

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FIFO ADVANTAGES
87

Logical pricing method (follows usual physical flow) Easy to understand and explain Inventory valuation near to a valuation based on replacement cost

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FIFO Disadvantages
88

Cumbersome to operate (must monitor each batch individually) Managers may find it difficult to compare costs and make decisions due to varying prices

During high inflation, issue prices lag behind current market value
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LIFO Advantages
89

Goods issued at prices close to current market value Managers continually aware of recent costs when making decisions

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LIFO Disadvantages
90

Cumbersome to operate (must monitor each batch individually) Often opposite to the physical flow of goods (where earlier items used first) Decision-making difficult because of variations in prices) Not accepted by IAS
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AVCO Advantages
91

Fluctuations in prices smoothed out

Easier to administer than FIFO or LIFO as there is no need to identify each batch separately.

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AVCO Disadvantages
92

Resulting issue price is rarely an actual price

Prices tend to lag behind current market values under inflationary conditions.

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