04/06/2024

ACCOUNTING FOR
MATERIALS

ACCOUNTING FOR MATERIALS

Introduction

• Materials cost is one of the important elements of cost of

product or unit
• For material cost control purposes, it is very essential to
know the important aspects of material, material control
and material purchase control
• Materials needs to be properly procured, well stored and
economically used as well as proper accounting for them

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Definition
• The term “materials‟ as used in cost and management account, covers a wide
range of items
– Raw Materials
– Example, flour and sugar for biscuit, or wood for furniture
– Work-in-Process
• Usually these are partly completed goods
– Components or “piece parts‟
– Finished products for use or sale
• Bag of cement or bottles for drinking water
– Indirect materials
• Example stationery, fuel and lubricants, and cleaning materials

Classification of Materials

• Direct Materials
– They can be easily identified with a particular cost unit
and hence Direct Materials are part of Prime Cost of a
factory
– Indirect Materials
• Indirect materials indirectly used for conversion from raw
materials into finished products.

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Materials need for Various Sectors

– Manufacturing-sector companies
– Purchase materials and components and convert them
into different finished goods
– Merchandising-sector companies
– Purchase and then sell tangible products without
changing their basic form
– Service-sector companies
– Provide services or intangible products to their
customers—for example, legal advice or audits

Inventoriable and Non-Inventoriable

Costs

• Inventoriable costs
– Are either the complete set or a subset of
manufacturing costs, and non-manufacturing costs are
never included as inventoriable costs

• Non-inventoriable costs
– These costs are treated as expenses of the accounting
period in which they are incurred because they are
expected not to benefit future periods

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Purchasing Control and Procedure

• Dr. Walters defines scientific purchasing as the
“Procurement by purchase of the proper materials,
machinery, equipment and supplies of stores used in
the manufacture of a product, adapted to marketing
in the proper quantity and quality at the proper time
and the lowest price consistent with the quality
desired”
• Alford and Beatty, “Purchasing is the procuring of
materials, supplies, machines tools and services
required for the equipment, maintenance and
operation of a manufacturing plant”.

Steps in Material Control

• Production control/inventory control/store keeper or
departmental managers initiates the need for purchasing
materials
• Search for possible suppliers
– Tenders
– Quotation
– Single shopping
– Government Procurement Services Agency
• Supplier selection
• Dispatch of purchase order
• Monitoring of deliveries
• Receipt of goods

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Procurement/Purchasing
• Procurement is the purchases of goods and
services at the best possible price to meet
purchasers’ demand in terms of quantity, quality,
dimension and size
• A form known as ‘Purchase Requisition’ is commonly
used as a formal request to purchase department
to purchase the required material
• Purchase department places an order with a
supplier, offering to buy certain material at stated
price and terms after receiving the purchases
requisition

Receiving the Materials

• The receiving department performs the function

of unloading and unpacking materials which are
received by an organization
• This will need an inspection report which is
sometimes incorporated in the receiving report,
indicating the items accepted and rejected with
reasons

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Recording of Materials in Bin Card

and Ledger Cards

Bin card
• A Bin card, also known as Bin Tag or Stock card, is
a card showing quantitative record of the receipts,
issues and closing balances of the material kept in
the corresponding bin

BIN CARD LAYOUT

BIN CARD
Bin No. ……………
Description: ……………
Department…………
Maximum Quantity: ………
Store Ledger Folio: …..
Minimum Quantity: ………..
Code No ………
Ordering Level: ………….
Receipts Issues Balance Remarks
Date GRN No. Quantity Date Requisition No Quantity Quantity Goods on
order and
audit Notes

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Stores Ledger

• Stores Ledger is a record of stores, both in

quantity and value and is maintained by the stores
Accountant
• It is similar to Bin card but with the main
difference that value of material is shown in the
Stores ledger
• Stores Ledger is an important book and the
account of each item of stores is maintained
separately

Store Ledger Card Layout

STORES LEDGER CARD

Description Unit Location Code

Maximum Minimum Re-order level Re-order quantity

Date Receipts Issues Balance

Quan Rate Amount Quan Rate Amount Quan Rate Amount

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Valuation of stock
• The general principle for valuation is that stock
must be valued at cost
• The question which arises here, is what is cost?
Is it replacement cost or historical cost?

Methods of stock valuation

• First-in-first-out(FIFO)
• Last-in-first-out(LIFO)
• Weight average cost (WAVCO)

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First-in-first-out
• This method assumes that the first stock to be received
is the first to be sold
• The cost of materials used is based on the oldest prices
• The closing stock is valued at the most recent prices

Last-in-first-out (LIFO)
• This method assumes that the last stock to be received is
the first to be sold
• Therefore, the cost of materials used is based on the
most recent prices
• The closing stock is valued at the oldest prices

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Weight average cost (WAVCO)

• This method assumes that the cost of materials used and
closing stock are valued at the weighted average cost

Stock control level

• The stores should control its stock at an appropriate level
so as to minimize the costs related to stock
• These cost can be classified into three categories:
– Costs of obtaining stock
– Carrying cost
– Stock-out-cost

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Cost of obtaining stock/ordering

cost
• Purchase costs of goods acquired
• Carriage inwards
• Administrative costs of purchasing and accounts
department

Stock-out cost
• Loss of sale revenue due to the stop in production
• Reduction in future sales because of the loss of goodwill
• Higher costs for urgent and small order of materials

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Cost of storage (carrying cost)

• Storage and handling cost
• Interest on capital tied up by the stock
• Insurance and security
• Stock loss due to deterioration, obsolescence and
pilferage
• Audit, stocktaking and stock recording cost

Economic Order Quantity

(EOQ)
EOQ is the size of the order which
contributes towards maintaining the stocks of
material at the optimal level and at a minimum
cost

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The formula
EOQ = 2*O*Q
C

Where EOQ = Economic Order Quantity

O= order cost per order
Q = Annual quantity required in units
C =Carrying cost per unit per annum

Example
• The annual consumption of a part “X” is 5000 units.
The procurement cost per order is Tshs. 10 and
the cost per unit is Tshs. 0.5. The storage and
carrying cost is 10% of the material unit cost.
Required:
Calculate the EOQ

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Solution
• O= Tshs.10 Q= Tshs. 5000, C= Tshs.
0.5*10%

EOQ = 2 O Q
C

EOQ = 2 * 5000 *10

0.5*10%
= 1414 units

Cost Tshs

120

Total cost
Minimum cost
80
Carrying cost

40 Ordering cost

EOQ=1414 units Unit per order

400 1200 2000

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• The graph shows the line representing ordering

cost sloping downward, indicating lower cost when
a large quantity is purchased and the line
representing cost of carrying stock going upward,
indicating a higher cost for a large quantity

Level setting
• It is to determine the correct or most optimal
stock level so as to avoid overstocking or
understocking of materials
• These levels are known as the Maximum, Minimum
and Re-order levels

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Re-order level

• The level of stock of material at

which a new order for the material
should be placed
• The formula:
Re-order level
= (Maximum usage * Maximum lead time )

Re-order quantity
• Reorder quantity is the size of each order
• The formula:

Reorder quantity = Maximum stock –(Reorder level –

Minimum usage in minimum lead
time)

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Maximum level
• The maximum stock level is highest
level of stock planned to be held
• Any amount above the maximum level
will be considered as excessive stock
• The formula:
Maximum level
= re-order level + Re-order quantity(EOQ) –Minimum
anticipated usage in Minimum lead

Minimum level/Safety stock

• The minimum level is that level of stock that
provides a safety buffer in the event of
increased demand or reduced receipt of stock
caused by the lengthening of lead time
• The stock level should not be allowed to fall
below the safety stock
• The formula:

Minimum level=
Re-order level – Average usage in average lead time

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Units

Maximum level
1500

Reorder level
1000

Minimum level
500

Weeks

Example

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Average usage 100 units per week

Minimum usage 70 units per week
Maximum usage 140 units per week
Lead time (the time 3-5 weeks
between ordering and
replenishment of goods)
Ordering cost per order TZS180
Annual cost of carrying a TZS5.2
unit in stock

• Calculate:
– Economic Order Quantity (EOQ)
– Reorder level
– Reorder quantity
– Minimum level
– Maximum level

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• Economic Order Quantity (EOQ)

EOQ = 2 O Q
C

EOQ = 2 * TZS180 *5200

5.2
= 600 units

• Reorder level
Re-order level
= (Maximum consumption * Maximum re-order period )

= 140 units *5
= 700 units

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• Minimum level
Minimum level
= Re-order level – Average usage in average lead time
= 700 units – (100 units *4)
= 300 units

• Maximum level

Maximum level
= re-order level + EOQ –Minimum anticipated usage
in Minimum lead

= 700 units +600 units – (70 units *3)

= 1090 units

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• Reorder quantity
Reorder quantity = Maximum stock –(Reorder level –
Minimum usage in minimum lead
time)

= 1090 units – (700 units – 70 units *3)

= 600 units

Just-in-time (JIT)
• Just-in-time (JIT) purchasing is the purchase of goods or
materials such that a delivery immediately precedes demand
or use Companies moving toward JIT purchasing argue that
the cost of carrying inventories (parameter C in the EOQ
model) has been dramatically underestimated in the past
• Just in time is a ‘pull’ system of production, so actual orders
provide a signal for when a product should be manufactured.
Demand-pull enables a firm to produce only what is required,
in the correct quantity and at the correct time

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Just in Time Conti…

• This means that stock levels of raw materials,
components, work in progress and finished goods can be
kept to a minimum. This requires a carefully planned
scheduling and flow of resources through the production
process. Modern manufacturing firms use sophisticated
production scheduling software to plan production for
each period of time, which includes ordering the correct
stock. Information is exchanged with suppliers and
customers through EDI (Electronic Data Interchange)
to help ensure that every detail is correct

Advantages JIT
• Lower stock holding means a reduction in storage space which
saves rent and insurance costs
• As stock is only obtained when it is needed, less working capital
is tied up in stock
• There is less likelihood of stock perishing, becoming obsolete
or out of date
• Avoids the build-up of unsold finished product that can occur
with sudden changes in demand
• Less time is spent on checking and re-working the product of
others as the emphasis is on getting the work right first time

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Disadvantages JIT
• There is little room for mistakes as minimal stock is kept for
re-working faulty product
• Production is very reliant on suppliers and if stock is not
delivered on time, the whole production schedule can be
delayed
• There is no spare finished product available to meet
unexpected orders, because all product is made to meet
actual orders – however, JIT is a very responsive method of
production

Backflush Costing
• Backflush accounting is a cost accounting system which
focuses on the output of an organization and then works
backwards to attributed costs to stock and cost of sales
• Backflush costing describes a costing system that delays
recording some or all of the journal entries relating to
the cycle from purchase of direct materials to the sale
of finished goods. Where journal entries for one or more
stages in the cycle are omitted, the journal entries for a
subsequent stage use normal or standard costs to work
backward to flush out the costs in the cycle for which
journal entries were not made

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The variants of Backflush accounting

• There are number variants of the Backflush system, each
differing as to the ‘trigger points’ at which costs are
recognized within the cost accounts and thus associated
with products. All variants, however, have the following
common features
• The focus is on output – costs are first associated with
output (measured as either sales or completed production )
and then allocated between stocks and costs of goods sold
by working back.

The variants of Backflush

accounting
• Conversion costs (labour and overheads) are never
attached to products until they are complete (or
even sold ) – thus the traditional WIP account
doesn’t exist. Materials are recognized at different
points according to the variant used, but only to the
extent of being either stock of raw materials or part
of the cost of stock of finished goods. Again,
materials are not attached to WIP.

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CELL PRODUCTION
• Cell production is a management technique under
Lean production that helps alienate all forms of
waste in the production process and so producing
more by using fewer inputs. It is a form of teamwork
where workers are organised into multi-skilled teams
and each team is responsible for a particular part of
the production

CELL PRODUCTION conti…

• Cell production has the flow production line split into a
number of self-contained units. Each team or ‘cell’ is
responsible for a significant part of the finished article
and, rather than each person only carrying out only one
very specific task, team members are skilled at a number
of roles, so it provides a means for job rotation
• Cell production is a form of team working and helps ensure
worker commitment, as each cell is responsible for a
complete unit of work, which Herzberg sees as part of job
enrichment

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Benefits of cell production

• Closeness of cell members should improve

communication, avoiding confusion arising from
misunderstood or non-received messages
• Workers become multi-skilled and more adaptable to
the future needs of a business
• Greater worker motivation, arising from variety of
work, team working and more responsibility
• Quality improvements as each cell has ‘ownership’ for
quality on its area

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