Chapter 2Chapter 2

Accounting for MaterialsAccounting for Materials

Learning ObjectivesLearning Objectives

LO1LO1 Recognize the two basic aspects of Recognize the two basic aspects of material control.material control.

LO2LO2 Specify internal control procedures Specify internal control procedures for for materials.materials.

LO3LO3 Account for materials and relate Account for materials and relate materials accounting to the general materials accounting to the general ledger.ledger.

Learning ObjectivesLearning Objectives

LO4LO4 Account for inventories in a just-in-Account for inventories in a just-in-time system.time system.

LO5LO5 Account for scrap materials, spoiled Account for scrap materials, spoiled goods, and defective work.goods, and defective work.

Effective Cost ControlEffective Cost Control

1.1. A specific assignment of duties and responsibilities.A specific assignment of duties and responsibilities.2.2. A list of individuals who are authorized to approve A list of individuals who are authorized to approve

expenditures.expenditures.3.3. An established plan of objectives and goals.An established plan of objectives and goals.4.4. Regular reports showing the differences between Regular reports showing the differences between

goals and actual performance.goals and actual performance.5.5. A plan or corrective action designed to prevent A plan or corrective action designed to prevent

unfavorable differences from recurring.unfavorable differences from recurring.6.6. Follow-up procedures for corrective measures.Follow-up procedures for corrective measures.

Physical Control of Physical Control of MaterialsMaterials

Limited access to materials storage Limited access to materials storage areas.areas.

Segregation of duties.Segregation of duties. Accuracy in recording.Accuracy in recording.

Controlling the Controlling the Investment in MaterialsInvestment in Materials

Maintaining the appropriate level of raw Maintaining the appropriate level of raw materials is one of the most important materials is one of the most important objectives of materials control.objectives of materials control.

Inventory of sufficient size and diversity must Inventory of sufficient size and diversity must be maintained.be maintained.

Management must determine other working Management must determine other working capital needs in determining inventory levels.capital needs in determining inventory levels.

Adequate planning and control is required.Adequate planning and control is required.

Order PointOrder Point

A minimum level of inventory should be A minimum level of inventory should be determined for each type of raw material, determined for each type of raw material, and inventory records should indicate the and inventory records should indicate the cost and quantity of items on hand.cost and quantity of items on hand.

Order pointOrder point is the point at which an item is the point at which an item should be ordered.should be ordered.

Order Point (cont.)Order Point (cont.)

The following items need to be taken The following items need to be taken into consideration when ordering:into consideration when ordering:

1.1. Usage – anticipated rate at which the material will be Usage – anticipated rate at which the material will be used.used.

2.2. Lead time – estimated time interval between the Lead time – estimated time interval between the placement of an order and the receipt of the material placement of an order and the receipt of the material ordered.ordered.

3.3. Safety stock – estimated minimum level of inventory Safety stock – estimated minimum level of inventory needed to protect against stockouts.needed to protect against stockouts.

(Daily usage X Lead time) + Safety stock = Order point(Daily usage X Lead time) + Safety stock = Order point

Economic Order Quantity Economic Order Quantity (EOQ)(EOQ)

The optimal quantity to order at one time.The optimal quantity to order at one time. Minimizes the total order and carrying costs over a Minimizes the total order and carrying costs over a

period of time.period of time. Ordering costsOrdering costs may include the salaries and wages may include the salaries and wages

of purchasing personnel, communication costs, and of purchasing personnel, communication costs, and materials accounting and record keeping.materials accounting and record keeping.

Carrying costsCarrying costs are the costs that a company may are the costs that a company may incur in storing materials. These costs may include incur in storing materials. These costs may include materials storage and handling costs, interest, materials storage and handling costs, interest, insurance, and property taxes, loss due to theft, insurance, and property taxes, loss due to theft, deterioration, or obsolescence, and records and deterioration, or obsolescence, and records and supplies associated with carrying inventory.supplies associated with carrying inventory.

Calculating EOQCalculating EOQ

EOQ = Economic EOQ = Economic Order QuantityOrder Quantity

C = Cost of placing C = Cost of placing an orderan order

N = Number of units N = Number of units required annuallyrequired annually

K = Annual carrying K = Annual carrying cost per unit of cost per unit of inventoryinventory

EOQ =EOQ = 2CN

K

Materials Control Materials Control ProceduresProcedures

Materials Control PersonnelMaterials Control Personnel Purchasing Agent – employee who does the Purchasing Agent – employee who does the

buying of raw materials.buying of raw materials. Receiving Clerk – employee who is responsible Receiving Clerk – employee who is responsible

for the receipt of incoming shipments.for the receipt of incoming shipments. Storeroom Keeper – employee who has charge Storeroom Keeper – employee who has charge

of the materials after they have been received.of the materials after they have been received. Production Department Supervisor – employee Production Department Supervisor – employee

who is responsible for the operational functions who is responsible for the operational functions within the department.within the department.

Control During Control During ProcurementProcurement

When the order point is reached the When the order point is reached the procurement process begins.procurement process begins.

Supporting documents are essential to Supporting documents are essential to maintain control during the procurement maintain control during the procurement process.process.

Documents Common to Documents Common to the Procurement Processthe Procurement Process

Purchase RequisitionPurchase Requisition – the form used to notify the – the form used to notify the purchasing agent that materials are needed.purchasing agent that materials are needed.

Purchase OrderPurchase Order – the purchase requisition that gives – the purchase requisition that gives the purchasing agent authority to order the materials.the purchasing agent authority to order the materials.

Vendor’s InvoiceVendor’s Invoice – the invoice from the vendor that – the invoice from the vendor that should be compared to the purchase order.should be compared to the purchase order.

Receiving ReportReceiving Report – the form that the receiving clerk – the form that the receiving clerk uses to count and identify the materials received.uses to count and identify the materials received.

Debit-Credit MemorandumDebit-Credit Memorandum – the document that is – the document that is used when the shipment of materials does used when the shipment of materials does notnot match match the order and/or the invoice.the order and/or the invoice.

Control During Storage Control During Storage and Issuanceand Issuance

Materials RequisitionMaterials Requisition Prepared by the authorized factory Prepared by the authorized factory

personnel to withdraw materials from personnel to withdraw materials from the storeroom.the storeroom.

Returned Materials ReportReturned Materials Report Describes the materials being returned Describes the materials being returned

to the storeroom and the reason for to the storeroom and the reason for the return.the return.

Materials AccountingMaterials Accounting

The materials accounting system must The materials accounting system must be integrated with the general ledger.be integrated with the general ledger.

Purchases are recorded as debits to Purchases are recorded as debits to materials in the general ledger.materials in the general ledger.

Materials account is supported by a Materials account is supported by a subsidiary subsidiary storesstores or or materials ledgermaterials ledger in in which there is an individual account for which there is an individual account for each item.each item.

Determining the Cost of Determining the Cost of Materials IssuedMaterials Issued

In selecting the method to be used, the In selecting the method to be used, the company should review their accounting company should review their accounting policies and the federal and state tax policies and the federal and state tax regulations.regulations.

The The flow of materialsflow of materials does not dictate the does not dictate the flow of costsflow of costs.. Flow of materials – the order that materials Flow of materials – the order that materials

are issued for use in the factory.are issued for use in the factory. Flow of costs – the order in which unit costs Flow of costs – the order in which unit costs

are assigned to materials.are assigned to materials.

Cost Flow MethodsCost Flow Methods

First – In, First – Out Method (FIFO)First – In, First – Out Method (FIFO) Assumes that materials used in production are Assumes that materials used in production are

costed at the prices paid for the oldest costed at the prices paid for the oldest materials and the ending inventory is costed at materials and the ending inventory is costed at the prices paid for the most recent purchases.the prices paid for the most recent purchases.

Last – In, Last – Out Method (LIFO)Last – In, Last – Out Method (LIFO) Assumes that materials used in production are Assumes that materials used in production are

costed at the prices paid for the most recently costed at the prices paid for the most recently purchased prices, and the ending inventory is purchased prices, and the ending inventory is costed at prices paid for the earliest costed at prices paid for the earliest purchases.purchases.

Cost Flow Methods Cost Flow Methods (cont.)(cont.)

Moving Average MethodMoving Average Method Material issued and the ending Material issued and the ending

inventory are costed at the average inventory are costed at the average price. This average unit price is price. This average unit price is computed every time a new lot of computed every time a new lot of materials is received and it continues materials is received and it continues to be used until another lot is to be used until another lot is purchased.purchased.

Accounting ProceduresAccounting Procedures

The purpose of materials accounting is to The purpose of materials accounting is to provide a summary from the general provide a summary from the general ledger of the total cost of materials ledger of the total cost of materials purchased and used in manufacturing.purchased and used in manufacturing.

All materials issued during the month and All materials issued during the month and materials returned to stock are recorded materials returned to stock are recorded on a on a summary of materials issued and summary of materials issued and returned formreturned form..

Selected Materials Selected Materials Accounting TransactionsAccounting Transactions

Materials Materials purchasedpurchased from vendor. from vendor.MaterialsMaterials XXXX

Accounts PayableAccounts Payable XXXX

Materials Materials issuedissued to production. to production.Work in ProcessWork in Process XXXX

MaterialsMaterials XXXX

Selected Accounting Selected Accounting TransactionsTransactions

Payment to vendor for invoice.Payment to vendor for invoice.

Accounts PayableAccounts Payable XXXX

CashCash XXXX

Transfer finished work to finished goods.Transfer finished work to finished goods.Finished GoodsFinished Goods XXXX

Work in ProcessWork in Process XXXX

Selected Sales-Related Selected Sales-Related Accounting TransactionsAccounting Transactions

Sale of finished goods on account.Sale of finished goods on account.Accounts ReceivableAccounts Receivable XXXX

SalesSales XXXX

Cost of Goods SoldCost of Goods Sold XXXX

Finished Goods InventoryFinished Goods Inventory XXXX

Collection of cash from customer.Collection of cash from customer.

CashCash XXXX

Accounts ReceivableAccounts Receivable XXXX

Just-In-Time (JIT) Just-In-Time (JIT) Materials ControlMaterials Control

Materials are delivered to a factory Materials are delivered to a factory immediately prior to their use in immediately prior to their use in production.production.

Reduces inventory carrying costs.Reduces inventory carrying costs. Reducing inventory levels through JIT Reducing inventory levels through JIT

may increase processing speed.may increase processing speed. Backflush costingBackflush costing is the accounting is the accounting

system used by JIT systems.system used by JIT systems.

Traditional and Backflush Traditional and Backflush Accounting SystemsAccounting Systems

Traditional SystemTraditional System MaterialsMaterials xxxx

Accounts PayableAccounts Payable xx xx Work in ProcessWork in Process xxxx

MaterialsMaterials xx xx Work in ProcessWork in Process xxxx

PayrollPayroll xx xx Factory OverheadFactory Overhead xxxx

Various CreditsVarious Credits xx xx

Work in ProcessWork in Process xxxx Factory OverheadFactory Overhead

xx xx Finished GoodsFinished Goods xxxx

Work in ProcessWork in Process xx xx

Cost of Goods SoldCost of Goods Sold xxxx Finished GoodsFinished Goods

xx xx

Backflush SystemBackflush System Raw and In-ProcessRaw and In-Process xxxx

Accounts PayableAccounts Payable xx xx No entryNo entry

Conversion CostsConversion Costs xxxx PayrollPayroll xx xx

Conversion CostsConversion Costs xxxx Various CreditsVarious Credits

xx xx No entryNo entry

Finished GoodsFinished Goods xxxx Conversion CostsConversion Costs xxxx

Raw and In-ProcessRaw and In-Process xx xx Cost of Goods SoldCost of Goods Sold xxxx

Finished GoodsFinished Goods xx xx

Accounting for Scrap Accounting for Scrap WorkWork

Scrap may be Scrap may be considered waste considered waste materials from the materials from the production process. production process. These are materials These are materials that can not be used that can not be used in the production in the production process.process.

Journal entry if the value Journal entry if the value of scrap is relatively highof scrap is relatively high

Scrap MaterialsScrap Materials XXXX

Scrap RevenueScrap Revenue XXXX

CashCash XXXX

Scrap MaterialsScrap Materials XXXX

Journal entry if the value Journal entry if the value of scrap is unknown.of scrap is unknown.

CashCash XXXX

Scrap RevenueScrap Revenue XXXX

Spoiled and Defective Spoiled and Defective WorkWork

Spoiled workSpoiled work has imperfections that has imperfections that cannot be economically corrected. The cannot be economically corrected. The loss can be treated as part of the cost of loss can be treated as part of the cost of the job or charge to Factory Overhead.the job or charge to Factory Overhead.

Defective workDefective work has imperfections that has imperfections that are correctable. The extra costs are are correctable. The extra costs are either charged to the job or Factory either charged to the job or Factory Overhead.Overhead.