Accounting for Materials Economic Order Quantity (EOQ)
Materials
➢ Means any commodity or substance which isprocessed
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.
➢ 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:
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.
Accounting for Labor
Labor
➢ The physical or mental effort exerted by individuals in the
creation of a product.
➢ Labor cost is the price paid for using human resources
➢ The compensation paid to employees who engage in
production related activities represent factory labor.
➢ A second major element of cost.
Direct Labor – represents payroll costs that are allocated
directly to the product.
Indirect labor – labor costs incurred for a variety of jobs that
are related to the production process but are considered either
too remote or too insignificant to be charged directly to
production.
Wages – payments made on an hourly, daily, or piecework
basis.
Salaries – fixed payments made regularly for managerial or
clerical services.
The accounting system of a manufacturer must include the
following procedures for recording payroll costs.
1. Recording the numbers of hours used in total and by
job.
2. Recording the quantity produced by the workers.
3. Analyzing the hours used by employees to determine
how time is to be charged.
4. Allocation of payroll costs to jobs and factory
overhead accounts.
5. Preparation of the payroll, including computation and
recording of the employees gross earnings, deductions,
and net earnings.
Wage Plan – the plan established by management
❖ Hourly-Rate Plan
Under this plan, a definite rate per hour is set for each
employee. The employees wages are calculated by multiplying
the rate per hour by the number of hours worked.
❖ Piece-Rate Plan
Under this plan, earnings are calculated by multiplying
the employee’s output by the rate per piece.
❖ Modified Wage Plan
This plan combines the features of hourly-rate and
piece-rate plans. Minimum hourly wage will be paid by the
company even if an established quota of production is not
attained by an employee. If the established quota is exceeded,
an additional payment per piece would be added to the
minimum wage level.
 Proper Costing of Labor
❖ Payroll
A calculation of all employee’s compensation,
statutory contributions, taxes, deductions, and net payment for
a certain time period. The formal document to present payroll is
called payroll register.
❖ Payslip
A document that explains the components of an
individual’s pay for a certain time period. It is a personal version
of payroll register.
Special Considerations in Factory Labor:
➢ When the jobs are rush, overtime pay is normally
encountered to cover the extra hours the worker has
rendered. Normally, overtime premium is charged to
factory overhead. However, if because of a rush job, it
is inevitable to work overtime, the whole overtime pay is
charged to production.
➢ Workers are also paid during idle time. Idle time refers to
the time workers has no work to perform due to
temporary changes in production setup. This is charged
to FOH. However, a loss account is to be established when
the changes in production is due to negligence or
inefficiency.
Normal Idle Time – waste of time which we can not stop
because it is normal and employer has to pay laborers for this
idle time. Examples: Walking time from one department to
other department, consuming time to set the machines, etc.
Abnormal Idle Time – wastage of time which we can stop by
good supervision, Examples: Waste of time due to inefficiency
of engineers, delay of supply of material to factory, strike and
lockout, etc.
Computation of Net Pay
According to Labor Code of the Philippines:
➢ Normal Hours of Work
The normal hours of work of any employee shall not
exceed 8 hours a day.
➢ Meal Periods
Not less than 60 minutes for regular meals of employees
which is non- compensable. Rest periods or coffee
breaks running from 5 to 20 minutes shall be considered
compensable working time.
➢ Right to Weekly Rest Day
Not less than 24 hours after every 6 normal work days.
➢ Night-Shift Differential
Refers to the additional compensation for work performed
from 10 O’clock in the evening to 6 O’clock in the
morning. Plus 10% of the hourly rate for work.
➢ Overtime Pay
Refers to the additional pay for work performed in excess
of 8 hours a day. Plus 25% of the hourly rate for work
performed in excess of 8 hours on ordinary day. Work
performed beyond 8 hours on a holiday or rest day shall be
paid an additional compensation equivalent to the rate of
the first eight hours on a holiday or rest day plus at least
30% thereof.
➢ Holiday Pay (Regular Holiday)
For work performed on a regular holiday, plus 100% or a
total of 200% of the employee’s daily wage rate.
➢ Compensation for Rest Day, Sunday or Holiday Work

Plus 30% of the daily basic rate or a total of 130% for work
performed on rest day or special day.

Plus 50% of the daily basic rate or a total of 150% for work
performed on special day falling on the employee’s rest
day.

Plus 30% of the daily basic rate or a total of 260% for work
performed on a regular holiday falling on the employee’s
rest day.

Regular Holidays and Nationwide Special Days

(ART.94 Sec.26 of Labor Code of the Philippines)

 Regular Holidays

New Years Day – January 1

Maundy Thursday – Movable date

Good Friday – Movable date

Eidul Fitr – Movable date

Eidul Adha – Movable date

Araw ng Kagitingan - Monday nearest April 9

Labor Day – Monday nearest May 1

Independence Day – Monday nearest June 12

National Heroes Day – Last Monday of Aug.

Bonifacio Day – Monday nearest Nov.30

Christmas Day – December 25

Rizal Day – Monday nearest Dec.30

 Nationwide Special Holidays

Ninoy Aquino Day – Monday nearest Aug.21

All Saints Day – November 1

Last Day of the year – December 31