√ACC 102: ACCOUNTING FOR MATERIAL

Material is one of the cost elements in determining cost of a product. In costing, items of
materials might be regarded as either direct materials or indirect materials.

Direct materials are the raw materials from which the product is made. It can be classified further
as:

 Raw materials which are needed to produce a finished product. For example, flour and
butter for bread, cocoa for beverages or cement and sand for moulding blocks.
 Work-in-progress which refers to semi-produced raw materials or a processed raw
material at a given point in time.
 Finished products for use or sale, e.g. cork for bottled drinks.

Indirect materials are consumables used in production, e.g. stationery, fuel and lubricants,
cleaning items etc.

MATERIALS ACQUISITION (Ordering, Receiving and Issuing of Materials)

Every movement of a particular material in an organization should be documented using the

following forms/documents as appropriate.

 Purchase Requisition Form (PRF)

 Purchase Order Form (POF)
 Goods Received Note (GRN)
 Material Requisition Note (MRN)
 Material transfer Note (MTN)
 Material Returned Note (MRN)

Purchase Requisition Form

This is a formal request for materials to be bought. This might be prepared by a member of the
stores staff, or produced automatically by a computer systems when the level of stocks gets down
to a pre-specified re-order level. Alternatively, the requisition might be prepared by the person or
department requiring the goods, who must state the quantity of each type of material required,
description of the goods, quality specification, the account to be charged, suggested name of the
supplier and the point of delivery. A purchase requisition must be authorized by an appropriate
person, such as the stores manager, typically by means of a signature on the form. Check any
cost accounting text for Purchase requisition specimen.

Purchase Order Form

It is an order placed with a supplier for the purchase of goods. Buying department whose job is
to process authorized purchase requisition, place purchase order with suitable suppliers on
receipt of a properly authorized purchase requisition after a thorough selection from the
suppliers. The selection will be based on price, delivery promise, quality and the past history of
dealings with the suppliers. The purchase order normally contains the name, and address of the
purchasing orgainsation, name of the supplier, date of order, terms of payment, price, delivery
instructions and date of delivery. It is usually raised in five copies and distributed as:

 Supplier
 Goods receiving department
 Account department
 Initiating department and
 Procurement department, for record purpose.

Good Received Note

Goods received note records the details of materials received from a suppliers, and includes
some extra items of data such as date, supplier’s name, purchase order number, quantity and
description of the goods, condition on arrival and details of returnable packing material. This
document is to be signed by the head of the department or any other authorized person. GRN is
the basis for entering receipt in the stores record. The number of copies of GRN to be raised
depends on the organization concerned. But in a big organization, five copies are to be raised and
distributed as follows:

 Purchase Department
 Originating department
 Stores
 Account department and
 Goods receiving department for reference purpose.

Purchase Invoices

It is the invoice received from a supplier. A copy of GRN will be sent to the purchasing
department attached to the copy of the purchase order. When supplier’s invoice is received, the
three documents will be passed to the appropriate individual to approve payment of the invoice.

Material Requisition Note

Request for material to be issued from stores to production department or the other department
are initiated and then authorized by a material requisition note. This document performs two
functions:

(i) It authorizes the storekeeper to release the goods, and

(ii) Acts as a source record for updating the stores ledger record and bin vard.
 The materials requisition note may also have a column to be filled in by the cost department,
for recording the cost or value of the materials issued to the cost centre job.

Material Transfer Note

Where materials, having been issued to one job or cost centre are transferred to a different
job or cost centre, without first returned to stores, a materials note should be raised. Such a
note must show not only the job receiving the transfer, but also the job from which it is
transferred. This enables the appropriate charges to be made to jobs or cost centre.

Material Returned Note

This document is the reverse of a requisition note, and must contain similar information. In
fact, it will be almost identical to a requisition note. It will simply have a different title and
distinctive colour, such as red, to highlight the fact that materials are being returned.

BIN CARD

A bin card is a simple record of receipts, issues and balances of stock in hand kept by
storekeeper.

THE STORE LEDGER

Accounting for direct materials is carried out in the stores ledger records. This is a detailed
record for each stock item, recording quantities received and issued and their cost or vale and the
value of current stock in hand. The ledger may be in form of loose-leaf binder, a card index or
more commonly perhaps, a computer printout.

THE INVENTORY COUNT (STOCK TAKE)

Stock take involves counting the physical inventory items are physically inventory at hand at a
particular date, then checking this against the balance shown in the inventory records. The count
can be carried out on a continuous or periodic basis.

PERIODIC STOCK TAKING

This is a process whereby all inventory items are physically counted and valued at a set point in
time, usually at the end of an accounting period. In other to carry out periodic stock taking, the
following factors are essentials:

 Adequate number of personnel must be available with clear instructions on what to do;
 Effect of the stocktaking exercise on production should be considered. It is therefore
appropriate to embark on stock taking at night or on weekends;
 Stores are to be clearly designated into physical units and all such units are to be counted;
  Stock takes should also ensure that only valid stock items are included and properly
checked;
 The completed stock sheets should have random, independent checks to verify their
correctness.

CONTINOUS STOCK TAKING

This is counting and valuing selected items at different times on rotation basis. This involves a
specialist team counting and checking a number of inventory item each day, so that each item is
checked at least once a year. Valuable item or items with a high turnover could be checked more
frequently.

PERPETUAL INVENTORY

This refers to 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. This means that there
is a continuous record of the balance of each item of inventory. The balance on the stores ledger
account therefore represents the inventory on hand and this balance is used in the calculation of
closing inventory in monthly and annual accounts.

INVENTORY MANAGEMENT TECHNIQUES

There are many types of inventory management techniques which the manager may acquint
himself with. Any or a combination of them could be very handy when deciding on:

 How much should be ordered

 When it should be ordered.

The first question which relates to the economic order quantity (EOQ) could be approached by
analyzing the cost of maintaining a certain level of inventory. When to order arises because of
the uncertainties that are associated with production and sales. This is the problem of trying to
determine the reorder point.

DETERMINATION OF OPTIMUM INVENTORY LEVEL

Two types of costs are encountered in this exercise: (i) the cost of ordering and (ii) the cost of
carrying a given level of inventory.

Ordering cost includes the cost of making requisition, purchase order, transportation, receiving
and store placement. The ordering cost is a function of the number of orders placed. Therefore,
the more frequent the order, the higher the ordering cost. Large inventory levels attract few
orders and lessen the ordering cost. In other words, ordering cost decreases with increased size of
inventory.
Carrying costs are costs that are associated with holding a given level of inventory. They include,
(i) the opportunity cost of funds tied up, (ii) insurance, (iii) storage (fencing, rent, racks, bins,
depreciation) (iv) deterioration and obsolescence. Opportunity cost is the forgone earnings on the
best alterative investment. Carrying cost moves in direct proportion with inventory size. To keep
carrying cost low; inventory should be purchased in small sizes and very frequently.

Therefore, there is a conflict, because as one tries to reduce ordering cost, carrying cost will
increase, hence a tradeoff between ordering and carrying cost is required. This tradeoff is called
Economic Order Quantity (EOQ). Thus, the EOQ is that inventory level which minimizes the
total of ordering and carrying costs. It could be calculated using the order formula approach,
graphic method and the analytical method.

Under certain assumptions the EOQ could be calculated with a high degree of certainty. The
assumptions are:

i) Total annual demand is known

ii) Usage of materials is steady
iii) The ordering cost per order and carrying cost per unit is known and constant.

The order-Formula Approach

In this approach, we are concerned in deriving a formula that will reduce the total cost; i.e.
carrying and ordering costs.

Assuming the ordering cost per order (o) is constant irrespective of the size of order, then
total order cost for the year will be got by multiplying the number of orders by the ordering
cost per order. How do you get number of orders? If A represents the annual requirement and
Q the order size, the number of orders will be A/Q. Total ordering cost will then be AO/Q.

Assume also that the carrying cost per unit (c) is constant, the total carrying cost will be
equal to the average inventory units for the period multiply by the carrying cost per unit. If Q
still represents the order size and usage is assumed constant; average inventory is Q/2. Total
carrying cost will be Qc/2. Total inventory cost i.e. ordering cost plus carrying cost will be
AO/Q+Qc/2. Therefore, there must be a trade off between both costs to get EOQ. Thus, if
total cost= Tc;

Tc = Ao + Qc ……………………….(i)
Q 2

Differentiating the total cost function with respect to Q

DTc = AQ + C……………………(ii)
dQ Q 2

Rearrange the equation and set it equal to zero

C - AO = o ………………….(iii)
2 Q2

Solve for Q

C - AO
2 Q2 ………………………….(iv)

C2Q = 2AO …………………….(v)

Q2 = 2AO
C …………………….(vi)

Therefore

EOQ = √ 2AC
C
Illustration

The following information relates to the operations of Ify and Cliff Partners

Annual demand = 3000 units (A)

Ordering cost per order = N30 (O)
Carrying cost per unit = N2 (C)

Require: Calculate the Economic Order Quantity

Q = √2AQ
C

Q = √2 x 3000 x 30
2

Q = √ 90,000

Q = 300 units

Illustration 2

Relevant cost for various order quantities

Order quantity 200 300 400

Average stock units 100 150 200

Number of purchase order 15 10 7.5

Annual holding cost N200 N300 N400

Annual ordering cost N450 N300 N225

Total relevant cost N650 N600 N625

Notes:

1. If there are no stocks when the order is received and the unit is used at a constant rate, the
average stock will be the half of the quantity ordered.
2. The number of purchase orders is ascertained by dividing the total annual demand of
3000 units by the order quantity.
3. The annual holding cost is ascertained by multiplying the average stock by the holding
cost of N2 per unit.
4. Annual ordering cost equals ordering cost per order N30 multiply by the number of
orders.