CHAPTER 6:

Accounting for Materials

JMCNNCPA
Summary of topics

 Business papers/documents related to material transactions

 Material Inventory System
 Methods of Costing Materials
 Control procedures over materials
 Economic Order Quantity (EOQ)
 Accounting treatment for discounts and freight-in
 Accounting for Spoiled, Defective, Scrap and Waste materials
Business papers/documents related to
material transactions

Purchase Requisition (PR)

 It is a written request usually sent to inform the purchasing department of a
need of materials or supplies
 From requesting department to purchasing department
Business papers/documents related to
material transactions
Business papers/documents related to
material transactions

Purchase Order (PO)

 It is a written request to a supplier for specified goods at an agreed upon
price
 It is the supplier’s authorization to deliver goods and submit a bill
 PO is usually in four copies, sent and kept by the supplier (original),
purchasing department, accounting department, and receiving
department
Business papers/documents related to
material transactions
Business papers/documents related to
material transactions

Receiving Report (RR)

 It is a written report as to quantity, quality and specifications of delivered
items from the supplier
 As good internal control, the quantity ordered is not shown on the copy of
PO sent to receiving department
 RR is usually in three copies, sent and kept by the receiving department
(original), purchasing department, and accounting department
Business papers/documents related to
material transactions
Business papers/documents related to
material transactions

Materials Requisition Form

 It is a written order to storekeeper to deliver materials or supplies to the
place designated or to issue the materials to the person presenting a
properly executed requisition
 The cost entered on the materials requisition is the amount charged to
production for materials consumed
Business papers/documents related to
material transactions
Material Inventory System
Periodic Inventory System Perpetual Inventory System
 Records purchases under  Records purchases under
“Purchases” account “Materials Inventory” account

 Beginning Materials Inventory are  Beginning Materials Inventory are

recorded under “Materials
Inventory, beg.” account the amount of ending materials
inventory from previous period

 Ending inventory amount is

determined by Physical count  Ending inventory amount is easily
determined thru records

 Cost of materials issued is

computed by deducting Ending  Cost of materials issued is easily
Materials inventory from Total determined thru records
Materials Available for use
Methods of Costing Materials

Inventory

Costing
System
Periodic Perpetual
Method

FIFO FIFO FIFO

Periodic Perpetual

Average Weighted Moving

Average Average
Methods of Costing Materials
First-in, First-out (FIFO)
 It is based on assumption that materials that were acquired first are first to
be issued in the production
 Manufacturing cost or Direct Material cost consist of the cost of materials in
the earlier purchases
 Ending inventory balance is the cost of materials in the recent purchase
 Under FIFO periodic, ending inventory balance is computed by looking on
the records of the recent purchases and based on physical count. Cost of
direct materials used is computed using the formula in the Cost of Goods
Sold Statement
 Under FIFO perpetual, both ending inventory balance and Cost of direct
materials used can be easily traced in the material stock card
 FIFO periodic and FIFO perpetual will provide same results
Methods of Costing Materials
Average Method
Weighted Average
 this is used for periodic inventory system
 the average cost is weighted by the number of units acquired at each
price
 the ending inventory balance is computed by multiplying the weighted
average cost by the units on hand

Moving Average
 this is used for perpetual inventory system
 a new weighted average unit cost is calculated after each new purchase
Exercise: Problem 7
Exercise: Problem 7
Exercise: Problem 7
Exercise: Problem 7
Control procedures over materials
Commonly Used Control Procedures
1. Order cycling  materials on hand are reviewed on a regular or periodic
cycle (e.g. 90-60-30 day method)
2. Min-max Method  the minimum quantity will represent the order point.
Order is placed to increase the inventory to the maximum level.
3. Two-bin Method  When the first bin is emptied, an order is placed. The
contents of the second bin will be used until the receipt of the order
4. Automatic Order System  used by by most companies that are
computerized. An order is automatically placed when the level of inventory
reaches a predetermined order point quantity
5. ABC Plan  it is systematic of grouping materials into separate classification
and determining the degree of control that each group requires.
(Categories A, B & C)
Control procedures over materials
Two basic aspects of materials control
1. Physical Control
A. Limited Access
B. Segregation of Duties
C. Accuracy of Recording
2. Control of the Investment
A. Order Point
B. Economic Order Quantity
Control procedures over materials
ORDER POINT
 The predetermined minimum level of inventory on hand at which on order
should be placed

Order Point = (Usage X Lead Time) + Safety Stock

Usage  the anticipated rate at which the material will be used

Lead Time  the estimated time interval between the placement of an order
and receipt of the material
Safety Stock  the estimated minimum level of inventory needed to protect
against running out of stock
Safety Stock = (Max. Lead time – Normal Lead Time) X Average usage
Safety Stock = (Max. Usage – Normal Usage) X Average Lead time
Control procedures over materials
ECONOMIC ORDER QUANTITY (EOQ)
 The quantity of order which results in the minimum total inventory cost (total
ordering cost and total carrying cost)
Tabular Method
 calculation of EOQ using table with the following column heads:
Order Size = number of units per order (given)
No. of orders = annual qty/order size
Total Order Cost = No. or orders X Cost per Order
Average Inventory = Order size/2
Total Carrying Cost = Ave. Inventory X Carrying cost per unit
Total order & carrying cost = Total order cost + Total Carrying cost
 The alternative with lowest total order & carrying cost will be the EOQ
 Total ordering costs and total carrying costs vary inversely
Control procedures over materials
ECONOMIC ORDER QUANTITY (EOQ)
Formula Method

Where: C = cost per order

N = no. of units required annually
K = carrying cost per unit
Exercise: Problem 2
Exercise: Problem 2
Exercise: Problem 14

1. Safety stock (5 days x 100 units) 500 units

2. Reorder point (5 days x 600 units) 3,000 units

3. Normal maximum inventory = (3,500/2) + 500 units = 2,250 units

4. Absolute maximum inventory = 3,500 + 500 units = 4,000 units

Accounting treatment for discounts and
freight-in
DISCOUNT
1. Trade Discount  the amount by which a manufacturer reduces the retail
price of a product when it sells to a reseller, rather than to the end customer.
 not recorded on the books
2, Quantity Discount  cost savings for bulk purchases
 not recorded on the books
3. Cash Discount  granted to customer to motivate them to pay promptly
 recoded in the books
 Ordinary dating/EOM/ROG
Accounting treatment for discounts and
freight-in
Methods of recording cash discount
a. When taken method
 purchases and liabilities are recorded at GROSS amounts at the time of purchase
 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 amounts at the time of purchase
 when payment is made after the lapse of the discount period, the discount not
availed of is charged to “Purchase Discount Loss”
c. When offered method
 Purchases are recorded at NET and the liability is recorded at GROSS
 The difference is charged to “Allow. For Purchase Discount”
 when payment is made after the lapse of the discount period, the discount not
availed of is charged to “Purchase Discount Loss”
 Regardless on timing of payment, “Allow. For Purchase Discount” will be closed upon
payment
Accounting treatment for discounts and
freight-in
FREIGHT-IN
1. Direct charging
 freight is added to the invoice price
 the account debited is Materials
 If two or more types of materials are purchased, freight must be
allocated using the following methods:
a. Relative Peso Value Method
b. Relative Weight Method
2. Indirect charging
 freight is charged to Factory Overhead Control account
Exercise: Problem 4
Exercise: Problem 4
Accounting for Spoiled, Defective, Scrap
and Waste materials
SPOILED UNITS
 Units that do not meet production standards and are either sold for their
salvage value or discarded

Accounting for Spoiled Units

1. Charged to the specific job
 reason for spoilage is the job itself
 do not include allow. For spoiled units on the total unit cost
 The effect will increase the unit cost of the remaining good units in the job
 The amount debited for spoiled goods and credited to WIP is equal to the
number of units spoiled multiplied by the estimated sales value per unit
 Pro-forma entry:
Spoiled Goods XX
WIP XX
Accounting for Spoiled, Defective, Scrap
and Waste materials
 Computation of new unit cost
a. WIP balance divided by no. of remaining good units
b, Cost of Spoiled Units XXX
Amount recovered from sale (XXX)
Loss on Spoiled Goods XXX
Divide: No. of good units XXX
Additional unit cost XXX
Initial unit cost XXX
New unit cost XXX

2. Charged to all production

 reason is considered normal to the process and the number does not exceed the limit
set by the Company
 includes allow. For spoiled units on the total unit cost
 no effect on unit cost
 the amount debited to spoiled goods is equal to the number of units spoiled multiplied
by the sales value per unit, the amount credited to WIP the total cost of the spoiled units
charged in the production, the difference will become loss and will be charged to FOH control
 Pro-forma entry:
Spoiled Goods XX
FOH Control XX
WIP XX
Accounting for Spoiled, Defective, Scrap
and Waste materials
DEFECTIVE UNITS
 Units that do not meet production standards and must be processed further in
order to be salable as good units or as irregulars

Accounting for Defective Units

1. Charged to the specific job
 reason for spoilage is the job itself
 do not include allow. For defective units on the total unit cost
 additional cost incurred will be charged to all units in job by debiting WIP
 The effect will increase the unit cost of all units in the job
 Pro-forma entry:
WIP XX
Materials XX
Labor XX
FOH Applied XX
Accounting for Spoiled, Defective, Scrap
and Waste materials
2. Charged to all production
 reason is considered normal to the process and the number does not
exceed the limit set by the Company
 includes allow. For defective units on the total unit cost
 no effect on unit cost
 Pro-forma entry:
FOH Control XX
Materials XX
Labor XX
FOH Applied XX
Accounting for Spoiled, Defective, Scrap
and Waste materials
SCRAP MATERIALS
 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 nominal amount

Accounting for Scrap Materials

1. Scrap can be traced to specific job
Scrap Materials XX
WIP XX
2. Scrap cannot be traced to specific job
Scrap Materials XX
Misc. Income XX
3. Scrap recovered from factory supplies
Scrap Materials XX
FOH Control XX
Accounting for Spoiled, Defective, Scrap
and Waste materials
WASTE MATERIALS
 Left over from the production process that has no further use or resale value
and may require cost for their disposal

Accounting for Waste Materials

1. Allocated to all jobs
FOH Control XX
A/P XX
2. Allocated to specific job
WIP XX
A/P XX
Exercise: Problem 9
Exercise: Problem 9
Exercise: Problem 10
Exercise: Problem 10
Exercise: Problem 10
THANK YOU!
JMCNNCPA