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    Chapter 3

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    kjudani1207

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    © All Rights Reserved
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    of 24
    LEARNING OBJECTIVES After studying this chapter, you should be able to: * describe the materials recording procedure; explain the accounting treatment of holiday pay, overtime premiums, employment costs, stores losses and delivery and materials handling costs; é distinguish between first in, first out (FIFO), last in, first out (LIFO) and average cost methods of stores pricing; © * justify which costs are relevant and should be included in the calculation of the economic order quantity (EOQ); calculate the EOQ using the tabulation and formula methods; describe the ABC classification method; outline the main features of a just-in-time approach. o * « he assignment of direct labour and materials to cost objects merely involves the implementation of suitable data processing procédures to identify the quantity and prices of the resources consumed. By contrast, indirect labour and material costs are classified as overheads and the costs are assigned to overhead accounts and then allocated to cost objects using the cost allocation Procedures described in the next chapter. CHAPTER 3 ACCOUNTING FOR DIRECT costs jal costs that have i labour and material i snitially examine how direct labo Se ot oot ne bene 2 el be ‘accumulated for allocating costs eae aha oa a wwonioies for internal and external profi reporting e LE multi aid the emphasis is on using future costs rather than os sect oan customers ree 1 me the agreed selling of past cst sw ‘or quotations, which, accepts etal ee rocratlon i ices. ‘The assignment of actual costs incurred may provi prices. future bids, but past ‘improve the accuracy.of ic on tho accuracy of he Oe and hele 1 lon-making. Exceptions do exist, however, not directly us ny : cat a nema pc ropare on the bas of ata oss ee® sl i ess of accounting for labour and materials requires a eens ra Oe Tecording procedures and documentation. 8 simply the presentation, and help you understand the recording procedures, insau oe ave procedures are described. You should note, however, the recording procedure i computerized. Nevertheless, the basic principles described in this chapter still apply. Inthe latter partof the chapter we shall focus on the management of inventories (stocks). Inventory management is of vital importance in both manufacturing and merchandising crganizations. In manufacturing organizations inventories consist of raw materials, work in progress and finished goods. Merchandising companies such as supermarkets, retail departmental stores and wholesalers sell tangible products that they have previously purchased in the same basic form from suppliers. Therefore they have only finished goods inventory. Inventory management is of little importance in service organizations since they have minimal inventories. Itis‘essential that inventories are managed efficiently so that such investments do not eral aaa sae im oe determine its optimum level of investment , = and, to do this, two conflicting requirements. must be met. First, it must cnet that inventories are sufficient to meet the requirements of production and sales; ane, second, it must avoid holding surplus inventories that are unnecessary because of the casts involved. The optimal inventory level les somewhere between these two mes. Our objective in the latter part of the chapter is to exami Sci is te icatic quantitative models for determining the optimum investment in havotlaros, se ACCOUNTING TREATMEN Nest Ties T OF VARIOUS LABOUR CHAPTER 3 ACCOUNTING FOR DIRECT CosTS ae ners luring a regular working week. Overtime and night-shift work Is usually ce ae oe Inaba ly high level of activity, not by specific products or customers. It istherefore rte to record activities undertaken during overtime or night hours as pe ot Foe tne” their counterparts undertaken during the normal working day. If, Wore ef ae Or shift premiums are a direct result of a customer's urgent request for the completion of the order and not due to the general pressure of work, then the ee ond i prémiums Should be charged directly to the customer. It is important that overtime andl shift premiums are also analyzed by departments for cost control purposes. Consider a situation where an employee is paid the normal hourly rate plus a premium of 60 per cent for Weekly hours worked in excess.of 40 hours. Assume that the employee works for 50 hours and that the ten hours of overtime were spent on a particular activity. The nmal hourly wage rate is £12: The employee's weekly wage will be calculated as follows: Normal time rate wage: 50 hours at £12 £600 Overtime premium (50% of 10 hours at £12) _ £60 #680 The normal time rate wage will be allocated to the’activities on which the employee was engaged during the period, but if the overtime was a result of demand exceeding productive capacity, it would be unreasonable to charge the overtime premium to the particular activity merely because it was scheduled to be produced during the overtime period. In such circumstances it would be preferable to charge the overtime premium to the appropriate overhead account, the total of which would be apportioned to all activities worked on during the period. Inaddition to the wage and salary payments to employees, the employer will incur a number of other employment casts. These include the employer's share of National/government ‘nsurance contributions and pension fund contributions. Some firms record employment costs as overheads, but itis preferable to calculate an average hourly rate for employment costs and add this to the hourly wage rate paid to the employees. For example, the employer may be responsible for employment costs of £60 per week for an operative who is paid £12 per hour for 40-hour week. Here we can establish that the employment costs are £1.50 per hour and this cost can be added to the hourly wage rate of £12 per hour, giving a total rate of £13.50 per hour. This approach is conceptually preferable to the alternative of charging the £60 to an overhead ‘ocount, since employment costs are a fundamental part of acquiring labour services. MATERIALS RECORDING PROCEDURE According to a survey by Drury and Tayles (2000) of 176 UK organizations, the cost of direct materials represented the dominant costs in manufacturing organizations, averaging 51 per cent of total costs for the responding organizations within the manufacturing sector. The accounting and contro! of materials is therefore of vital importance in manufacturing ‘organizations, In the remainder of this chapter the mechanismsfor recording and controlling ‘aterals are explained. Because of the importance to the manufacturing sector the focus. 1s mainly on manufacturing organizations but the materials recording procedure that is described is also applicable to non-manufacturing organizations, The materials recording Procedure involves the following stages: ® Storage of materials; ® purchase of materials; 49 CHAPTER 3 ACCOUNTING FOR DIRECT cosTs © receipt of materials; ® issue of materials; e assigning the cost of materials to cost objects. : Wye stages, although in most bar coding and other forms re described and illustrated rocedures for each of the abo. dure is computerized using e documents that al ter records. ‘We will describe the clerical p organizations the recording proce of online information recording. The sourc are likely to exist only in the form of comput Storage of materials In a manufacturing organization optimal inventory levels are main the stores department is responsible for ensuring that tained for each item of material in inventory. Thus, to control the quantity of inventories held, adequate records must be maintained for each Stores item. When items of materials have reached thelr re-order point a purchase rocuisition is initiated requesting the purchase department to obtain the re-order quantity from an appropriate supplier. Methods that are used for establishing optimum inventory levels, re-order points and re-order quantities will be explained later in this chapter. Purchase of materials When a purchase requisition is received, purchasing department staff select an appropriate supplier and then complete a purchase order requesting that the supplier supply the materials listed on the order. A copy of the purchase order is sent to the receiving section within the stores department for checking with the goods when they arrive. Receipt of materials ‘When the goods are received by the receiving section they are inspected and checked with the supplier's delivery note and a copy of the purchase order. The receiving section then lists the materials received on a goods received note (GRN) and forwards copies of the GRN to the purchasing and accounting departments. The purchasing department records thatthe order has been completed, and the accounting department checks the GRN with the sipelers ena to ensure that Payment is made only in respect of goods actually received. Ts caparin a a pWehnmlen 8 fo piee eda ef the items listed on the GRN. The GRN ; Is of the items received it it a bappropriate stores ledger account, as in Exhibit 3,1, This Gocumon seh ie | quantity and value of each individual item of material stored by atten. y the organization. Issue of materials The formal authorization for the issue of materials is and quantity of materials is ang pee le pire nnd ad lil also contains details of either ‘the customer's overhead account for which the materials are required. Exhibit 3.2 provides an illustration of a typi . a a typical stor lisiti the materials requisition are priced ration stlon. Each of the items li rom the informati penta led ek te KA ide spe ledger account. The information ae account and a balance of the quem and agg column ofthe appropri wantty and value is calculated for each tery ores eo item of material. 4 stores requisition, which lists the type CHAPTER 3 ACCOUNTING FOR DIRECT COSTS 51 (e) | EXHIBIT 3,1 Astores ledger account SE, ROA Ts REET 5 No. Astores requisition | Stores requi | Material required for: |. Product code’ or overhead account) { Department: 1s Date: Hee Be | Code | (Quantity) | Description no. Weight Rate | © | [Notes} | | "| Departmental Head Assigning the cost of materials to cost objects The total cost of the items of material listed on the stores requisition is assigned to the appropriate customer's account number, overhead account or product or service code, The details on the material requisition thus represent the source information for assigning the cost of the materials to the appropriate cost object. Thus the accounting entries "equired for an issue of materials involve: 1 Reducing the value of raw materials inventories by recording the values issued in the iscues column of the appropriate stores ledger account, 2 Assigning the cost of the issues to the appropriate customer's order number, Product/ service code oF overhead account. 52 CHAPTER 3 ACCOUNTING FOR DIRECT COSTS PRICING THE ISSUES OF MATERIALS 8 i is because the fic issue of materials. This is chabed at'several different prices. Actual He hod of pricing material issues must be It may be difficult to associate costs with a same type of material may have been pure! can take on several different values, and some met! i selected. Consider the situation presented in Example 3.1. a CN AB ae et i 1 each, ‘On 5 March Nordic purchased 5000 units of materials at £1 ea purchased on 30 March at £1.20 sach, During April, 6000 units wer ~ issues were made during April and you aré now preparing the month! There are three alternative methods that you might consider for calculating the cost of materials issued to job Z which.will impact on both the ‘cost of sales and the inventory valuation that is incorporated in the April monthly profit statement and balance sheet. First, you could assume that the first item received was the first item to be issued, that is first in, first out (FIFO). In the example the 5000 units issued to job Z would be priced at £1 and the closing inventory would be valued at £6000 (5000 units at £1.20 per unit). Second, you could assume that the last item to be received was the first item to be issued, that is, last in, first out (LIFO). Here a material cost of £6000 (5000 units at * £1.20 per unit) would be recorded against the cost of job Z and the closing inventory would be valued at £5000 (5000 units at £1 per unit). Third, you could issue the items at the average cost of the materials in inv fentory (12. £1.10 per unt). With an average cost system the job cost would be recorded at £5500 ¢ the closing inventory would also be valued at £5500, The following is a summary of {he three diferent materials pricing methods relating to Example 3.1: : Cost of sales fie. aie tojobZ) Closing inventory Total costs i «© «© First in, frst out (FIFO) 000 (5000 x £1) 6000 (5000 x £1.20) 11000 saa In fst out (FO) 6000 (6000 x 1.20) 5000 000 x £1) 11000 Werage cost 5500 (5000 x £1.10) 500 (6000 x £1.10) 11000 CHAPTER 3 ACCOUNTING FOR DIRECT.COSTS 53 would be obtained by using either of he other methods. Note also that the closing inventory will be at the latest, and therefore higher, prices. With the LIFO method the latest and higher prices are assigned to the cost of sales and therefore lower profits will be reported, compared with using either FIFO or average cost. The Value of the closing inventory will be at the earliest, and therefore lower, prices. Under the average cost method, the cost of sales and the closing 'Nventory will fall somewhere between the values recorded for the FIFO and LIFO methods, LIFO is not an acceptable method of pricing for taxation purposes in the UK and if it is used, the accounts must be adjusted for tax. Also the International Accounting Standard (IAS2) on inventory valuation state that LIFO does not bear a reasonable relationship to actual costs obtained during the period, and imply that this method is inappropriate for external reporting. In. view of these comments, the FIFO or the average cost method should be used for external financial accounting purposes. Instead of using FIFO or average cost for inventory valuation and profit measurement many organizations maintain their inventories at standard prices using a standard: costing system, which considerably simplifies pricing material issues. The above discussion relates to pricing the issue of materials for internal and external profit measurement and inventory valuation. Remember that, for decision-making the focus is on future costs, rather than the allocation of past costs, and therefore the choice of method of pricing materials is not normally an issue. In practice, pricing stores issues is not likely to be as simple as the. situation presented in Example 3.1. You should now refer to Example 3.2, which presents @ more complex situation, and then examine each of the entries in stores ledger The purchase and issue of a raw material by the Midshire Water Authority for a five-month period were as follows: ; 1 duly Received 2000 units at £10 per unit 9 July ; Received 520 units at £10.50 per unit 18 July Issued > 1400 units s 5 August Received 800 units at £11.50 per unit 22 August Received 600 units at £12.50 per unit 15 September "Issued 1240 units 140ctober Issued 480 units 8 November Received 1000 units at £11 per unit 24 November 'ssued 760 units © There was no opening inventory of the raw material. You are required to prepare the stores ledger accounts when issues are priced, respectively, according to the FIFO, LIFO and average cost methods, Please refer to Exhibit 3.3 for the answer, 4 CHAPTER 3 ACCOUNTING FOR DIRECT cOsTS | re presented in Exhibit 3.3. ‘ms exist for pricing stores ss will be carried accounts for the three different pricing methods that tice computer prograk Do remember, however, that in prac issues by the chosen method so it is most unlikely that the proce’ out manually. You should note in Exhibit 3.3 that with the FIFO ne the ne oO a eto Wanife is i vices. This is because : 15 September is at three different purchase P 400 ina a caret purchase of 2000 units have already been issued. The Font therefore the first items to be issued out of the 1240 units on 45 September. The next earliest purchase of 520 units is now issued; leaving a balance of 120 units to be issued from the purchase of 6 August. The closing inventory consists of the final purchase for the period of 1000 units plus 40 units from the 22 August purchase that have not yet been issued. Now refer to the LIFO method in Exhibit 3.3 and look at the issue of 480 units on 414 Ootober This issue includes the 160 units at the 5 August purchase price of £11.50 because all of the units from the latest purchase on 22 August have previously been issued, together with 640 units from the next latest purchase of 5 August. Only 160 units EXHIBIT 3, Pricing stores issues for the Midshire Water Authority 10.50 5: 3 18 " Aug 5 800 11.50 9200 hee 600 12,50 7500 Sept 15 ee He d 10,50 ee ee 44,80; 12840 | 1289 ee 1000 11.00 11000 |200 ia a 5 860 780 eo “The closing inventory represents: 40 units at e1. ‘ : 1 50 eee SNS = 214000 E1150, CHAPTER 3 ACCOUNTING FOR DIRECT COSTS 55 Stores ledger account ~ LIFO method Maximum quantity: Minimum quantity: issues Inventory SBN Quantity” Unit “Amount Quantity — Unit’ Amount | Quantity Unit Amount tiie lial) price (®) price (8) ee, ® © ® ‘uly t 2000 10.00 20000 2000 20000 he $20 10.50 5460 2520 25460 620 40,50 880 1400. 10.00. 14260]: 1120 31200 ‘Aug 5 800 11.50 9200 : 1920 20400 Aug 22 600 12.50 7500 2520 27900 Sept 15 000 he tebo 6401240 41.50. 14860 | 1260 13040 pale 2 160. 44:80 : ‘| 820° 480 7 10.00. S040} 800 8000 Nov 8 1000 41.00 14000 Sees Be 4800 49000 c 60. 1100. 6460] 4040 40640 The closing inventory represents: 800 units at £10.00 per unit = £8000 240 units at £11.00 per unit £2640 ‘Stores ledger account - average-cost method Code: ‘Maximum quantity Minimuim quantity Date Receipts ee igsues GRN Quantity Unit Amount'|Stores Quantity Unit. Amount ‘Amount no, price). | fed 35 price (By @) ©) SR ©: ‘ July 2000 10.00 20000 : 2000 10.00 20000 9 520. 10.60 5460 4 2520, 10.1082 25460 bye 1400 10.1082 14144! 1120 11316 800 11.50 9200} °° >. 1920 10.6854 20516 600° 12.60: 7500 2520 11.1175 28016 ea 4240 11.1175 13785 | 1280 14231 480 11.1175 5536) 800 8895 1000. 11.00 11.000 : 1800 11.0528 19895. 760 11.0528 8400} 1040 41495 £25460 UY = 5550 tne P71 0R2, e801 soust = * 220 uns as ‘Ss A i CHAPTER 3 ACCOUNTING FOR DIRECT COSTS we sot segue! fat es are available for issue. 7 in et neo Hence LIFO toes fio. a ope iu iter urchases Nave a hase price. The cosine earliest £10 as all the previous [alt PovGro at the latest purchase FT on units at always ensure that the ie 8 a a poe price of consists of 240 units at ; it 3.3 you purchase price of £10. tion of Exhibi od shown in the third s° er unit. This is it Finally, with the average cost meth n in tine average cost P i antity in Here a era by.the total qu nee ee ‘sai betel of the material in inventory YY calculated by dividing inventory after each new purchase. An tration of the average unit cost calculations urchase. An illustrati the after eacl i ic of Exhibit 3.3. An fo A in the third section of Exhibit $8. 20 st purchases is shown ty it ip oat pe eae oven the average cost method is that soe 7 fon if Hee = fl rest cance price at this average price changes only when a new P. cha’ the latest ave received. ISSUES RELATING 70 ACCOUNTING.FOR MATERIALS ir i relate In this section we examine three issues that relate to accounting for materials. They. to the treatment of: 1 stores losses; 2 materials delivery costs; and 3 materials handling costs. Treatment of stores losses To achieve accurate profit measurement, the clerical/computerized records in respect of each item of materials in inventory must be in agreement with the actual inventory held. This means that the actual inventor n ry must be physically counted and compared with the clerical or computer record. For this to be done effectively, there must be either Sometimes it may be found that t he actual inventor or computer records. The reasons fot ry level is different f i r this may be: it from the clerical 1 an entry having been made in the wrong stores ledger account; When 2 manual syst fem is operated; 4 thett of inventory, When a discrepancy arises the indivi Col must be ad the individual st ° ) lores ledk So that they are in agreement with the actual inventory. Assan "tt axa rae es . xample, that the Commercial Metals changes the method it uses to value inventories tt was decided in the first quarter 2016 that Commercial Metals Company Lid would change the accounting method it used to value its inventories. This change would be for its Americas Mills; Americas Recycling and Americas Fabrication segments. This development would see them using the weighted average cost method instead of the last in, first out method:

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