ACCOUNTING

FOR
MATERIALS

1
 2

LO1 Distinguish between the periodic and

perpetual inventory materials cost
accumulation systems.
LO2 Recognize the two basic aspects of
materials control.
LO3 Specify internal control procedures for
materials.
LO4 Compute for Economic Order Quantity.
LO5 Identify the different supporting
documents to support transactions
affecting materials.
 3

LO6 Determine what are included in the

inventory and what expenses are
included in the inventory
LO7 Determine the value of materials
using the different material
costing methods.
LO7 Determine the flow of
manufacturing costs
LO8 Account for materials and relate
materials accounting to the general
ledger.
LO9 Determine the effects of inventory
Inventory Systems
Two accounting systems are used to record
transactions involving inventory:

Perpetual
Perpetual Periodic
Periodic
Inventory
Inventory Inventory
Inventory
System
System System
System
The
The inventory
inventory
account The
The inventory
inventory
account is
is account
continuously
continuously account isis
updated adjusted
adjusted at
at the
the
updated asas end
purchases
purchases and
and end of
of aa
sales reporting
reporting cycle.
cycle.
sales are
are made.
made.
 5

Purchases and sales of inventory

recorded directly to Inventory
account
Inventory purchases, freight,
purchase returns and discounts are
debited to the Inventory account
Cost of Goods Sold (COGS) is
debited and Inventory is credited for
each sale
 6

Subsidiary ledger is maintained for

individual inventory items
Periodic inventory counts are still
required to ensure reliability
maintains a continuous record of
inventory changes
 Perpetual Inventory System
Lothridge Wholesale Beverage Company (LWBC)
purchases on account $600,000 of merchandise
for resale to customers.
GENERAL JOURNAL
Date Description Debit Credit
2009 Inventory 600,00
Accounts Payable 0 600,00
0

Returns
Returnsof
ofinventory
inventoryare
arecredited
creditedto
tothe
theinventory
inventoryaccount.
account.
Discounts
Discountson
oninventory
inventorypurchases
purchasescan
canbe
berecorded
recordedusing
using
the
thegross
grossor
ornet
netmethod.
method.
Perpetual Inventory System
LWBC sold, on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.

GENERAL JOURNAL
Date Description Debit Credit
2009Accounts Receivable 820,00
Sales 0 820,00
0
Cost of Goods Sold 540,00
Inventory 0 540,00
0
 9

Inventory purchases recorded

as a debit to Purchases account
COGS is a calculation on the
Income Statement
Physical inventory is counted
and verified periodically
updates inventory records only
periodically
 10

Under both periodic and

perpetual inventory systems,
physical counts of inventory are
conducted at least once a year
Any differences in counted and
recorded quantities are posted
to a separate account –
Inventory Over and Short
Periodic Inventory System

Beginning Inventory
+ Net Purchases
Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
Periodic Inventory System
LWBC purchases on account $600,000
of merchandise for resale to customers.

GENERAL JOURNAL
Date Description Debit Credit
2009 Purchases 600,00
Accounts Payable 0 600,00
0

Returns
Returnsof
ofinventory
inventoryare
arecredited
creditedto
tothe
thePurchase
Purchase
Returns
Returnsand
andAllowances
Allowancesaccount.
account.
Discounts
Discountsononinventory
inventorypurchases
purchasescan
canbe
berecorded
recorded
using
usingthe
thegross
grossor
ornet
netmethod.
method.
 Periodic Inventory System
LWBC sold on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.
GENERAL JOURNAL
Date Description Debit Credit
2009Accounts Receivable 820,0
Sales 00 820,0
00
No entry is made to record Cost of Goods Sold. Assuming Beginning
Inventory of $120,000, a physical count of Ending Inventory shows
a balance of $180,000. Let’s calculate Cost of Goods Sold at
the end of the accounting period.
Periodic Inventory System
Calculation of Cost of Goods Sold
Beginning inventory $ 120,000
Plus: Purchases 600,000
Cost of goods available for sale 720,000
Less: Ending inventory (180,000)
Cost of goods sold $ 540,000

Adjusting entry to determine Cost of Goods Sold

Date Description Debit Credit
12/31/09 Cost of Goods Sold 540,000
Inventory (ending) 180,000
Inventory (beginning) 120,000
Purchases 600,000
Comparison of Inventory Systems
 16

Perpetual and Periodic Systems:

Example
Felicity Limited reports the following data for
2014:
Beginning Inventory : 100 units at P6
Purchases: (all credit)
March 12: 300 units at P6
July 6: 600 units at P6
Sales: (all credit)
April 8: 200 units at P12
August 9: 400 units at P12
Ending Inventory: 400 units at P6
Provide all journal entries under each
method.
 17

Perpetual System

Date Record Inventory Changes Record Sales Re

March 12 Inventory 1,800
Accts Payable 1,800
April 8 Cost of goods sold 1,200 Accts Receiv. 2,
Inventory 180 Sales 2
(200 *P6) (200 * P12)

July 6 Inventory 3,600

Accts Payable 3,600
August 9 Cost of goods sold 2,400 Accts Receiv. 4,
Inventory 2,400 Sales 4
(400 * P6) (400 * P12)
 18

Perpetual System
Inventory Stock Card (Subsidiary Ledger)
Date Purchases Sales Balance

January 1 Opening 100

units
March 12 300 units 400

April 8 200 units 200

July 6 600 units 800

August 9 400 units 400 units

• Periodic inventory system would not normally

maintain a subsidiary ledger for inventory
 19

Periodic System
Date Record Inventory Changes Record Sales Revenue
March 12 Purchases 1,800
Accts Payable 1,800

April 8 No entry Accts Receiv 2,400

Sales 2

July 6 Purchases 3,600

Accts Payable 3,600

August 9 No entry Accts Receiv 4,800

Sales 4

Dec. 31 Cost of goods sold 3,600

Inventory (ending) 2,400 Adjusting
Purchases 5,400 En
Inventory (beg) 600
 20

Financial Statement
Presentation
Perpetual Periodic
Net Sales Net Sales x,xxx
x,xxx Cost of Goods Sold:
Opening Inventory xxx
Cost of Goods Sold
Add: Net Purchases xxx
xxx Cost of Goods
Gross Profit Available for Sale xxx
x,xxx Less: Ending Inventory xxx
Cost of Goods Sold xxx
Gross Profit x,xxx
What is Included in Inventory?
General Rule
All goods owned by the company on the inventory
date, regardless of their location.

Goods
Goodsin
inTransit
Transit Goods
Goodson
on
Consignment
Consignment

Depends
DependsononFOB
FOB
shipping
shippingterms.
terms.
Expenditures Included in Inventory

Invoice
Invoice Purchase
Purchase
Price
Price Returns
Returns

+
Freight-in
Freight-in Purchase
Purchase
on
on Discounts
Discounts
Purchases
Purchases
 23

An Effective Cost Control System

1. A specific assignment of duties and
responsibilities.
2. A list of individuals who are authorized to
approve expenditures.
3. An established plan of objectives and goals.
4. Regular reports showing the differences
between goals and actual performance.
5. A plan of corrective action designed to
prevent unfavorable variances from
recurring.
6. Follow-up procedures for corrective
measures.
 24

MATERIAL CONTROL
Inventory control is important for:

- ensuring availability of inventory

items
- preventing excessive accumulation
of inventory items
 25

2 Basic Aspects of Materials Control

Physical Control or safeguarding
materials
Limited Access
Segregation of Duties
Accuracy in recording
Control of the investment in
material
Controlling
26

the Investment in
Materials
 Maintaining the appropriate level of raw
materials is one of the most important
objectives of materials control.
 An inventory of sufficient size and variety
for efficient operations must be maintained.
 Management should consider other working
capital needs in determining inventory
levels.
 Adequate planning and control is required.
 27

Order Point
A minimum level of inventory should
be determined for each type of raw
material, and inventory records should
indicate how much of each type is on
hand.
 Order point is the point at which an
item should be ordered.
 28

Order Point
 The following items need to be taken into
consideration when ordering:
1. Usage – anticipated rate at which the
material will be used.
2. Lead time – estimated time interval between
the placement of an order and the receipt of
the material.
3. Safety stock – estimated minimum level of
inventory needed to protect against
stockouts.
 (Daily usage X Lead time) + Safety stock
= Order point
 29
Economic Order Quantity
(EOQ)
 The optimal quantity to order at one time.
 Minimizes the total order and carrying costs
over a period of time.
 Ordering costs may include the salaries and
wages of purchasing personnel,
communication costs, and materials
accounting and record keeping.
 Carrying costs are the costs that a company
may incur in storing materials. These costs
may include materials storage and handling
costs, interest, insurance, and property taxes,
loss due to theft, deterioration, or
obsolescence, and records and supplies
associated with carrying inventory.
 30

Calculating EOQ
 EOQ = Economic Order
Quantity
 C = Cost of placing an 2CN
order EOQ =
 N = Number of units K
required annually
 K = Annual carrying
cost per unit of
inventory
 Materials Control 31

Procedures
 MaterialsControl Personnel
 Purchasing Agent – employee responsible
for buying the materials needed.
 Receiving Clerk – employee responsible for
supervising the receipt of incoming
shipments.
 Storeroom Keeper – employee in charge of
materials after they have been received.
 Production Department Supervisor –
employee responsible for supervising the
operational functions within the department.
Control During 32

Procurement
 When the order point is reached the
procurement process begins.
 Supporting documents are essential
to maintain control during the
procurement process.
 33

Documents Common to the

Procurement Process
 Purchase Requisition – the form used to notify
the purchasing agent that materials are needed.
 Purchase Order – the purchase requisition that
gives the purchasing agent authority to order the
materials.
 Vendor’s Invoice – the invoice from the vendor
that should be compared to the purchase order.
 Receiving Report – the form that the receiving
clerk uses to count and identify the materials
received.
 Debit-Credit Memorandum – the document
that is used when the shipment of materials does
not match the order and/or the invoice.
 34

Control During
Storage and Issuance
 Materials Requisition
 Prepared by the authorized factory
personnel to withdraw materials from
the storeroom.
 Returned Materials Report
 Describes the materials being returned
to the storeroom and the reason for the
return.
 35

Accounting for
Materials
 The materials accounting system must
be integrated with the general ledger.
 Purchases are recorded as debits to
materials in the general ledger.
 Materials account is supported by a
subsidiary stores or materials ledger
in which there is an individual account
for each item.
 36

Determining
the Cost of Materials Issued
 In selecting the method to be used, the
company should review their accounting
policies and tax regulations.
 The flow of materials does not dictate
the flow of costs.
 Flow of materials – the order that
materials are issued for use in the
factory.
 Flow of costs – the order in which unit
costs are assigned to materials.
 37

Flow
Flow of
of Manufacturing
Manufacturing Costs
Costs
•Direct Labor
•Factory Overhead

MATERIALS STOREROOM PRINTING PLANT

INK INK
Job 73

Materials Work in Process

Inventory Inventory
 38

Flow
Flow of
of Manufacturing
Manufacturing Costs
Costs

WAREHOUSE CAMPUS BOOKSTORE

Job 69
Job 70

Finished Goods Cost of Goods

Inventory Sold
 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM
Purchased

Cost of Goods Sold

Wages Payable Factory Overhead

Total
Wages

DM Direct materials used in production

 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM
Purchased
IM

Cost of Goods Sold

Wages Payable Factory Overhead

Total IM
Wages

IM Indirect materials used in production

 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM
Purchased
IM DL

Cost of Goods Sold

Wages Payable Factory Overhead

Total DL IM
Wages

DL Direct labor used in production

 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM
Purchased
IM DL

Cost of Goods Sold

Wages Payable Factory Overhead

Total DL IM
Wages
IL IL

IL Indirect labor used in production

 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM
Purchased
IM DL

Cost of Goods Sold

Wages Payable Factory Overhead

Total DL IM
Wages
IL IL

OFOH

OFOH Other factory overhead costs incurred

during production
 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM
Purchased
IM DL

FOHA
Cost of Goods Sold
Wages Payable Factory Overhead

Total DL IM FOHA
Wages
IL IL Based on
predetermined
OFOH
overhead rate

FOHA Factory overhead applied to work in process

 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM COGM COGM
Purchased
IM DL

FOHA
Cost of Goods Sold
Wages Payable Factory Overhead

Total DL IM FOHA
Wages
IL IL

OFOH

COGM Cost of goods manufactured and transferred

to finished goods
 Flow of Manufacturing Costs
Materials Work in Process Finished Goods
Materials DM DM COGM COGM SOLD
Purchased
IM DL

FOHA
Cost of Goods Sold
Wages Payable Factory Overhead SOLD

Total DL IM FOHA
Wages
IL IL

OFOH

SOLD Finished goods sold

 47

Flow
Flow of
of Manufacturing
Manufacturing Costs
Costs
Receiving
Receiving Materials received are
Report
Report
No. inspected by the
No.196
196
Receiving Department.
Once inspected, a
receiving report is
prepared showing the
quantity received and
its condition.
 48

Flow
Flow of
of Manufacturing
Manufacturing Costs
Costs
Receiving
Receiving
Report
Report Invoice
Invoice
No.
No.196
196

The receiving report and the invoice are used

to record the receipt of the merchandise and
to control the payment.
 49

Flow
Flow of
of Manufacturing
Manufacturing Costs
Costs
Receiving
Receiving
Report
Report Invoice
Invoice
No.
No.196
196

a. Materials 10 500 00
Accounts Payable
10 500 00
Materials purchased during
December.
 50

Flow
Flow of
of Manufacturing
Manufacturing Costs
Costs
Receiving
Receiving
Report
Report Invoice
Invoice
No.
No.196
196

The Materials account is a controlling

account. A separate account for each
type of material is maintained in a
subsidiary materials ledger.
 51

Receiving
Receiving
Report
Report
Direct
Direct Materials
Materials
No.
No.196
196

MATERIALS LEDGER ACCOUNT

MATERIAL: No. 23 Paper ORDER POINT: 1,000 lbs.
RECEIVED ISSUED BALANCE

Rec. Mat.
Report Req.
Unit
No. Quantity Amount No. Quantity Amount Date Quantity
Amount Price Dec. 1 1,200 $ 6,000 $5.00
672 400 $ 2,000 4 800 4,000 5.00

196 1,500 $10,500 8 800 4,000 5.00

1,500 10,500 7.00

First-in,
First-in, first-out
first-out
 52
Direct
Direct Materials
Materials

Later, Materials Requisition Number 704 is prepared for

Job No. 72 requisitioning 1,800 units of No. 23 paper.
MATERIALS LEDGER ACCOUNT
MATERIAL: No. 23 Paper ORDER POINT: 1,000 lbs.
RECEIVED ISSUED BALANCE

Rec. Mat.
Report Req.
Unit
No. Quantity Amount No. Quantity Amount Date Quantity
Amount Price Dec. 1 1,200 $ 6,000 $5.00
672 400 $ 2,000 4 800 4,000 5.00
196 1,500 $10,500 8 800 4,000 5.00
1,500 10,500 7.00
704 1,800 11,000 12 500 3,500 7.00

to Materials Requisition
 53

Direct
Direct Materials
Materials from Materials Ledger Account

MATERIALS REQUISITIONS
REQUISITION NO. 704
JOB NO. 72
Quantity Unit
Description Issued Price Amount

No. 23 paper 800 $5.00 $ 4,000

1,000 7.00 7,000
Total issued $11,000

to Job Cost
Sheet
 54

Direct
Direct Materials
Materials from Materials Requisition

Job 72
4,000 units of Algebra

Direct materials $11,000

Direct Labor
Factory Overhead

b. Work in Process 11 000 00

The receiving report and the invoice are
Materials
used
11 000 00 to record the receipt of the
merchandise and to control
Materials requisitioned to the payment.
Job 72.
55
 56

Cost Flow Assumptions

 The cost flow assumptions are:
 Specific identification
 Average cost
 First-in, First-out (FIFO)
 Last-in, First-out (LIFO)
 57

Specific Identification
 Items sold and purchased are individually
identified as to cost
 Works best with items that are unique,
high cost, with small numbers held as
inventory
 Advantage:
– Matches revenues and actual costs
 Disadvantages:
 May be costly to implement and maintain
 May lead to income manipulation
 58

Cost Flow Methods

 First – In, First – Out Method (FIFO)
 Assumes that materials used in production are
costed at the prices paid for the oldest
materials and the ending inventory is costed at
the prices paid for the most recent purchases.
 Last – In, Last – Out Method (LIFO)
 Assumes that materials used in production are
costed at the prices paid for the most recently
purchased prices, and the ending inventory is
costed at prices paid for the earliest purchases.
 59

Cost Flow Methods

(cont.)
 Moving Average Method
 Materialissued and the ending
inventory are costed at the average
price. This average unit price is
computed every time a new lot of
materials is received and it continues
to be used until another lot is
purchased.
 60

Decision Makers’ Perspective

Factors Influencing Method Choice

How closely do How well are

reported costs
costs reflect matched
actual against
flow of related
inventory? revenues?
How are income
taxes affected by
inventory
method choice?
 Cost Flow Assumptions: 61

Example
 Call-Mart reports the following transactions for
March
Date Purchases (Sold) Balance
1 beginning inventory (@P3.80) 500

2 1,500 units (@P4.00)

2,000
15 6,000 units (@P4.40) 8,000
19 (4,000 units sold) 4,000
30 2,000 units (@P4.75) 6,000

Determine the cost of goods sold and the cost of

ending inventory, under each cost flow assumption.
 62

Accounting Procedures
 The purpose of materials accounting is
to provide a summary from the general
ledger of the total cost of materials
purchased and used in manufacturing.
 All materials issued during the month
and materials returned to stock are
recorded on a summary of materials
issued and returned form.
 63

Average (weighted) Method

Date Purchases Unit Cost Purchase Cost
March 1 500 units P3.80 P 1,900
March 2 1,500 units P4.00 P 6,000
Aug 14 6,000 units P4.40 P26,400
Sep 18 2,000 units P4.75 P 9,500
10,000 units P43,800

Unit cost = P43,800  10,000 = P4.38

Cost of goods available Cost of goods sold Ending inventory

P43,800 4,000 X P4.38 = 17,5206,000 X P4.38 = P26,280

 64

First-in, First-out Method

Date Purchases Unit Cost Purchase Cost
March 1 500 units P3.80 P 1,900
March 2 1,500 units P4.00 P 6,000
Aug 14 6,000 units P4.40 P26,400
Sep 18 2,000 units P4.75 P 9,500

6,000 units
2,000 @ P4.75 = P 9,500
Ending inventory 4,000 @ P4.40 = 17,600
P27,100

Cost of goods available P43,800

Cost of goods sold P43,800 - P27,100 = P16,700

 65

Last-in, First-out Method

Date Purchases Unit Cost Purchase Cost
March 1 500 units P3.80 P 1,900
March 2 1,500 units P4.00 P 6,000
Aug 14 6,000 units P4.40 P26,400
Sep 18 2,000 units P4.75 P 9,500
6,000 units
500 @ P3.80 = P 1,900
1,500 @ P4.00 = 6,000
Ending inventory 4,000 @ P4.40 = 17,600
P25,500
Cost of goods available P43,800

Cost of goods sold 2,000 @ P4.40 = P 8,800

2,000 @ P4.75 = 9,500
P43,800 - P25,500 = P18,300 P18,300
 66

When Prices Are Rising . . .

FIFO LIFO
 Matches low (older)  Matches high (newer)
costs with current costs with current (higher)
(higher) sales. sales.
 Inventory is valued at
 Inventory is valued based
approximate replacement
cost. on low (older) cost basis.
 Results in higher taxable  Results in lower taxable

income. income.
 Not permitted by
international accounting
standards.
 67

Cost Flow Assumptions:

Notes
 The ending inventory in units is the
same in all three methods: the cost is
different
 The cost of goods sold and the cost of
ending inventory are different
 The cost of goods available is the same
in all three methods
 LIFO would result in the smallest
reported net income (with rising prices)
Selected Materials Accounting
Transactions
 Materials purchased from vendor.
Materials XX
Accounts XX
Payable
 Materials issued to production.
Work in Process XX
Materials XX

68
Selected Accounting
Transactions
 Payment to vendor for invoice.
Accounts XX
Payable
Cash XX
 Transfer finished work to finished
goods.
Finished Goods XX
Work in XX
Process

69
Selected Sales-Related
Accounting Transactions
 Sale of finished goods on account.
Accounts Receivable XX
Sales XX
Cost of Goods Sold XX
Finished Goods XX
Inventory
 Collection of cash from customer.
Cash XX
Accounts Receivable XX
70
 Effect of Inventory Errors
Ending Effect on Income Effect on Balance She
Inventory Statement Items Items

Under- COGS (over) Retained Earnings (under

stated Net Income (under) Working Capital (u

Over- COGS (under) Retained Earnings (over)

stated Net Income (over) Working Capita

71